bank run

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pages: 549 words: 147,112

The Lost Bank: The Story of Washington Mutual-The Biggest Bank Failure in American History by Kirsten Grind

asset-backed security, bank run, banking crisis, big-box store, call centre, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, fixed income, housing crisis, Maui Hawaii, money market fund, mortgage debt, naked short selling, NetJets, shareholder value, short selling, Shoshana Zuboff, Skype, too big to fail, Y2K

Despite the bickering, the WaMu executives’ concern was right on the mark. In just three days, customers pulled out a collective $1.5 billion, surpassing IndyMac’s giant deposit loss. “We had never seen anything like it,” said one of the deposit team managers later. WaMu’s own bank run was now, officially, under way. On the fourth day, a Tuesday, customers withdrew $1.8 billion. Together those two numbers represented about 2 percent of WaMu’s retail deposit base of $148.2 billion.* The last time WaMu had suffered through a bank run of this magnitude was in midst of the Great Depression.23 On a cold February morning in the winter of 1931, Seattle residents woke up to a banner headline in the local paper: the troubled Puget Sound Savings and Loan Association would not open the next day. WaMu customers read about the failed bank and worried about WaMu’s health.

“I will appreciate any help you can provide in snuffing out this ember.” To keep from further spooking customers, WaMu held off on closing about a hundred branches across the country that hadn’t been making money, and that had been scheduled to close before the run started. No one wanted to give the public any reason to think WaMu was shutting down. On the Tuesday when WaMu customers withdrew $1.8 billion, the bank run peaked. Then it began to subside. Bank runs, while they are sparked by unknown events, generally play out like a bubble, with a run-up, a climax, and a fall. WaMu’s run was no different. Soon deposit outflows fell back into the range of hundreds of millions of dollars. Two weeks after IndyMac’s failure, the WaMu panic ended. WaMu had lost a stunning $9.4 billion in deposits—nine times the amount of the much-publicized IndyMac run.

Not long after this exchange, Killinger and several members of WaMu’s executive team flew to Washington for a joint meeting with Reich, Bair, and their respective deputies. WaMu had called the meeting as a way to update the regulators on the bank’s financial condition following the bank run. They had no idea that their bank had fueled such a battle between the two agencies. In Reich’s conference room at the OTS’s frayed headquarters, Killinger and WaMu’s treasurer, Robert Williams, ran through WaMu’s capital and liquidity positions. WaMu was considered well capitalized, even though it had just posted a stunning $3.3 billion loss in the second quarter because of its bad loans—its highest quarterly loss ever. As a result of the bank run, the bank’s liquidity had drained to about $50 billion. The government agencies still deemed that amount healthy. Customers were bringing money back thanks to the 5 percent CD special.


Global Governance and Financial Crises by Meghnad Desai, Yahia Said

Asian financial crisis, bank run, banking crisis, Bretton Woods, business cycle, capital controls, central bank independence, corporate governance, creative destruction, credit crunch, crony capitalism, currency peg, deglobalization, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, floating exchange rates, frictionless, frictionless market, German hyperinflation, information asymmetry, knowledge economy, liberal capitalism, liberal world order, Long Term Capital Management, market bubble, Mexican peso crisis / tequila crisis, moral hazard, Nick Leeson, oil shock, open economy, price mechanism, price stability, Real Time Gross Settlement, rent-seeking, short selling, special drawing rights, structural adjustment programs, Tobin tax, transaction costs, Washington Consensus

It allows the bank to liquidate all its assets to meet the demands of the early withdrawers, but this has the effect of making the situation worse. First, because a bank run exhausts the bank’s assets at date 1, a late consumer who waits until date 2 to withdraw will be left with nothing, so whenever there is a bank run, it will involve all the late consumers and not just some of them. Second, if the market for the risky asset is illiquid, the sale of the representative bank’s holding of the risky asset will drive down the price, thus making it harder to meet the depositors’ demands. The all-or-nothing character of bank runs is, of course, familiar from the work of Diamond and Dybvig (1983). The difference is that in the present model bank runs are not “sunspot” phenomena: they occur only when there is no other equilibrium outcome possible. Furthermore, the deadweight cost of a bank run in this case is endogenous. There is a cost resulting from suboptimal risk sharing.

Because the risky asset cannot be liquidated at date 1, there is always something left to pay the late withdrawers at date 2. For this reason, bank runs are typically partial, that is, they involve only a fraction of the late consumers, unlike the Diamond–Dybvig (1983) model in which a bank run involves all the late consumers. As long as there is a positive value of the risky asset RX 0, there must be a positive fraction 1 ␣(R) 0 of late consumers who wait until the last period to withdraw. Otherwise the consumption of the late withdrawers c22(R)RX/(1␣(R)) would be infinite. Assuming that consumption is positive in both periods, an increase in ␣(R) must raise consumption at date 2 and lower it at date 1. Thus, when a bank run occurs in equilibrium, there will be a unique value of ␣(R) 1 that equates the consumption of early-withdrawing and late-withdrawing consumers.

The graphs in this figure represent the equilibrium consumption levels of early and late consumers, respectively, as a function of the risky asset return R. For high values of R (i.e. R R*), there is no possibility of a bank run. The consumption of early consumers is fixed by the standard deposit contract at c1(R) c and the consumption of late consumers is given by the budget constraint c2(R) L RX c. For lower values of R(R R*), it is impossible to pay the early consumers the fixed amount c promised by the standard deposit contract without violating the late consumers’ incentive constraint and a bank run inevitably ensues. However, there cannot be a partial run. The terms of the standard deposit contract require the bank to liquidate all of its assets at the second date if it cannot pay c to every depositor who demands it.


pages: 726 words: 172,988

The Bankers' New Clothes: What's Wrong With Banking and What to Do About It by Anat Admati, Martin Hellwig

Andrei Shleifer, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bonus culture, break the buck, business cycle, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversified portfolio, en.wikipedia.org, Exxon Valdez, financial deregulation, financial innovation, financial intermediation, fixed income, George Akerlof, Growth in a Time of Debt, income inequality, information asymmetry, invisible hand, Jean Tirole, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, Larry Wall, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, negative equity, Nick Leeson, Northern Rock, open economy, peer-to-peer lending, regulatory arbitrage, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Satyajit Das, shareholder value, sovereign wealth fund, technology bubble, The Market for Lemons, the payments system, too big to fail, Upton Sinclair, Yogi Berra

Ordinary payment processes show a mixture of randomness and predictability that allows the bank to pay its depositors without difficulties by maintaining some cash reserves. Problems arise, however, if many depositors demand their money at the same time. This could happen if depositors become worried about the bank’s solvency and try to get their money out before it is too late. As we know from the fate of the Bailey Building and Loan Association in the movie, this can give rise to a bank run. Bank runs are sometimes discussed as examples of self-fulfilling expectations; that is, events that become reality just because people expect them and act on the basis of these expectations. If investors fear that other investors are about to run and withdraw their money from the bank, it may make sense for them to run themselves and try to withdraw their money. They know that an important part of the bank’s funds is tied up in illiquid investments and that the promises the bank has made to depositors cannot be fulfilled if too many people want their money at the same time.

Following the Great Depression, in 1935 the United States created a federally guaranteed deposit insurance system to protect depositors from the consequences of bank failures and to prevent bank runs.22 When an insured bank fails, the FDIC takes over and winds the bank down without damage to the depositors.23 By now this process works so well that depositors do not go a day without access to their funds. Because they have nothing to fear and it is a hassle to move accounts from one bank to another, depositors tend to stay with the same bank for long periods of time. Deposit insurance is less well established in other countries, but depositors can still count on some form of protection in most places.24 The Breakdown of “3-6-3” Traditional Banking In the United States, the reforms of the 1930s were followed by four decades of exceptional stability in the banking industry. Bank runs were a thing of the past. Commercial banks and savings banks flourished because funding was stable and risks in lending relatively small.

See sovereign default default, by individuals, on mortgages. See mortgage default Delaware, bankruptcy in, 247n19 deleveraging, through asset sales, 64, 175, 257n19, 306n30 demand deposits: availability of, as benefit to economy, 49, 148; in balance sheets, 48, 248n4; in bank runs, 51–52, 150–53; as form of money, 294n10; in payment system, 49. See also deposit(s) Demirguç-Kunt, Asli, 251n24, 315n74 Demyanyk, Yuliya, 254nn43–44, 297n33 De Nicolò, Gianni, 249n12 Denmark, costs of bailouts in, 292n39 deposit(s): in balance sheets, 48–49; bank loans funded by, 48–49, 51–52; banknotes and, 149–50; in bank runs, 51–52; beneficial to economy, in payment system, 49, 148, 152–53; versus cash, 153, 154, 294n10; cost of, for banks, 111; as form of money, 150, 293n10; as funding sources of banks, 48–49, 51–52, 111, 150, 278n21; insurance on (See deposit insurance); in liquidity transformation, 155–56, 250n17; in maturity transformation, 51; as money-like debt, 154–56; in savings and loans institutions, 248n2; in solvency risks from maturity transformation, 51; as unique service of banks, 148; and vulnerability to runs, 150–53 deposit insurance: creditors protected by, 62, 163; in Europe, 242n25; as explicit guarantee, 129, 136–37, 139; functions of, 62; money market funds as lacking, 67, 93, 309n47; premium charged for, 111, 136–37; runs in absence of, 93, 273n46; in United States (See Federal Deposit Insurance Corporation; Federal Savings and Loan Insurance Corporation) Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 (U.S.), 251n28 deregulation: and concentration in financial sector, 89, 269n27; of interest rates, 54, 251n28; of mergers, 251n28; in savings and loan crisis of 1980s, 55, 252n35; of savings banks, 54–55, 94, 251n28 derivatives, 69–74; accounting rules for treatment of, 71, 85–86, 260n42, 266n11, 266n13; in bankruptcy, exceptions for, 164, 227, 236n35, 301n55, 336n57; clearinghouses for, 334n46; complexity of, 71–72; credit insurance as, 73–74; definition of, 69; forward contracts as, 69–70; gambling with, 70–71, 73, 123; history of, 70; in LTCM crisis of 1998, 72; netting of, 85–86, 267nn15–17; regulatory capture and, 204; rise of, 70; risks from, 70–73; scandals involving, 70–71, 328n6; transparency in, lack of, 71–72, 261n43; transparency in, proposal to increase, 204, 325n51; types of, 69–70, 260n37.


pages: 267 words: 71,123

End This Depression Now! by Paul Krugman

airline deregulation, Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, business cycle, capital asset pricing model, Carmen Reinhart, centre right, correlation does not imply causation, credit crunch, Credit Default Swap, currency manipulation / currency intervention, debt deflation, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, full employment, German hyperinflation, Gordon Gekko, Hyman Minsky, income inequality, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Rogoff, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, low skilled workers, Mark Zuckerberg, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, Paul Samuelson, price stability, quantitative easing, rent-seeking, Robert Gordon, Ronald Reagan, Upton Sinclair, We are the 99%, working poor, Works Progress Administration

Why, fear that the bank might be about to fail, perhaps because so many depositors are trying to get out. So banking carries with it, as an inevitable feature, the possibility of bank runs—sudden losses of confidence that cause panics, which end up becoming self-fulfilling prophecies. Furthermore, bank runs can be contagious, both because panic may spread to other banks and because one bank’s fire sales, by driving down the value of other banks’ assets, can push those other banks into the same kind of financial distress. As some readers may already have noticed, there’s a clear family resemblance between the logic of bank runs—­especially contagious bank runs—and that of the Minsky moment, in which everyone simultaneously tries to pay down debt. The main difference is that high levels of debt and leverage in the economy as a whole, making a Minsky moment possible, happen only occasionally, whereas banks are normally leveraged enough that a sudden loss of confidence can become a self-fulfilling prophecy.

The main difference is that high levels of debt and leverage in the economy as a whole, making a Minsky moment possible, happen only occasionally, whereas banks are normally leveraged enough that a sudden loss of confidence can become a self-fulfilling prophecy. The possibility of bank runs is more or less inherent in the nature of banking. Before the 1930s there were two main answers to the problem of bank runs. First, banks themselves tried to seem as solid as possible, both through appearances—that’s why bank buildings were so often massive marble structures—and by actually being very cautious. In the nineteenth century banks often had “capital ratios” of 20 or 25 percent—that is, the value of their deposits was only 75 or 80 percent of the value of their assets. This meant that a nineteenth-century bank could lose as much as 20 or 25 percent of the money it had lent out, and still be able to pay off its depositors in full.

On one side, Glass-Steagall established the Federal Deposit Insurance Corporation (FDIC), which guaranteed (and still guarantees) depositors against loss if their bank should happen to fail. If you’ve ever seen the movie It’s a Wonderful Life, which features a run on Jimmy Stewart’s bank, you might be interested to know that the scene is completely anachronistic: by the time the supposed bank run takes place, that is, just after World War II, deposits were already insured, and old-fashioned bank runs were things of the past. On the other side, Glass-Steagall limited the amount of risk banks could take. This was especially necessary given the establishment of deposit insurance, which could have created enormous “moral hazard.” That is, it could have created a situation in which bankers could raise lots of money, no questions asked—hey, it’s all government-insured—then put that money into high-risk, high-stakes investments, figuring that it was heads they win, tails taxpayers lose.


pages: 475 words: 155,554

The Default Line: The Inside Story of People, Banks and Entire Nations on the Edge by Faisal Islam

Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Big bang: deregulation of the City of London, Boris Johnson, British Empire, capital controls, carbon footprint, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, credit crunch, Credit Default Swap, crony capitalism, dark matter, deindustrialization, Deng Xiaoping, disintermediation, energy security, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, financial repression, floating exchange rates, forensic accounting, forward guidance, full employment, G4S, ghettoisation, global rebalancing, global reserve currency, hiring and firing, inflation targeting, Irish property bubble, Just-in-time delivery, labour market flexibility, light touch regulation, London Whale, Long Term Capital Management, margin call, market clearing, megacity, Mikhail Gorbachev, mini-job, mittelstand, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, negative equity, North Sea oil, Northern Rock, offshore financial centre, open economy, paradox of thrift, Pearl River Delta, pension reform, price mechanism, price stability, profit motive, quantitative easing, quantitative trading / quantitative finance, race to the bottom, regulatory arbitrage, reserve currency, reshoring, Right to Buy, rising living standards, Ronald Reagan, savings glut, shareholder value, sovereign wealth fund, The Chicago School, the payments system, too big to fail, trade route, transaction costs, two tier labour market, unorthodox policies, uranium enrichment, urban planning, value at risk, WikiLeaks, working-age population, zero-sum game

In the USA, such bank holidays had not been called since the Great Depression of the 1930s. I wondered if the Eurogroup geniuses who had set the Cypriot bank run in motion had ever read Roosevelt’s ‘fireside chat’, delivered on the radio in similar circumstances exactly eighty years previously: ‘It needs no prophet to tell you that when the people find that they can get their money – that they can get it when they want it for all legitimate purposes – the phantom of fear will soon be laid.’ Thus, in a statesmanlike way, Roosevelt used the broadcast media to boost confidence and douse the flames of financial panic. Sadly, no statesman of similar stature emerged in Europe during the Eurozone crisis. In 1933 Roosevelt stopped bank runs by creating deposit insurance. In 2013 the Troika created pent-up demand for a bank run by stopping deposit insurance. From big bang to basket case It should not be forgotten that Cyprus, two years before its financial collapse, was largely untroubled, fairly wealthy, and certainly not a basket case.

Dozens, if not hundreds, of journeys by truck and boat spread the new notes across the mainland and the islands, from Rhodes to Corfu, from Crete to Komotini near the Turkish border. Staff worked through the night to ensure that bank branches across Greece had sufficient notes to meet depositor demand, and so contain any incipient physical bank run. Incredibly, this operation proceeded without anyone noticing. The Bank of Greece tracked a demand for paper currency through bank branch orders for currency. Large withdrawals were normally granted with notice of a day or two. The Bank also noticed a spike in purchases of gold sovereigns. It did not have to deploy teams of ‘bank-run spotters’ as the Bank of England had done in the crisis of 2008. As far as ordinary Greeks were concerned, the cash machines continued to function. However, underneath their very noses a monetary revolution was taking place… The simple balance sheet of the Bank of Greece showed no disturbance from these tumultuous events on the stock of notes and coins in circulation in the country.

Greeks had responded to the uncertainty regarding the Troika’s next move by withdrawing euros from their bank accounts at a record rate. Soon there would be not enough euro notes in the country to cope with the number of Greeks trying to get their hands on their money from cash machines and bank branches. A secret plan was activated. A senior official overseeing Greece’s bailout told me that when it became known that the IMF were considering not paying out the final tranche, there was the beginning of a bank run. ‘We’re talking about June 2011,’ he told me, ‘when Greeks were taking about one to two billion euros a day from the banking system. And the Greeks had to send military planes to Italy to get banknotes. It got to that point.’ A decade after it gave up the drachma, the world’s oldest existing currency, Greece faced the crushing reality that it did not have the sovereign authority to meet the demand for paper currency from its own citizens.


pages: 611 words: 130,419

Narrative Economics: How Stories Go Viral and Drive Major Economic Events by Robert J. Shiller

agricultural Revolution, Albert Einstein, algorithmic trading, Andrei Shleifer, autonomous vehicles, bank run, banking crisis, basic income, bitcoin, blockchain, business cycle, butterfly effect, buy and hold, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, central bank independence, collective bargaining, computerized trading, corporate raider, correlation does not imply causation, cryptocurrency, Daniel Kahneman / Amos Tversky, debt deflation, disintermediation, Donald Trump, Edmond Halley, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, full employment, George Akerlof, germ theory of disease, German hyperinflation, Gunnar Myrdal, Gödel, Escher, Bach, Hacker Ethic, implied volatility, income inequality, inflation targeting, invention of radio, invention of the telegraph, Jean Tirole, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, litecoin, market bubble, money market fund, moral hazard, Northern Rock, nudge unit, Own Your Own Home, Paul Samuelson, Philip Mirowski, plutocrats, Plutocrats, Ponzi scheme, publish or perish, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, Satoshi Nakamoto, secular stagnation, shareholder value, Silicon Valley, speech recognition, Steve Jobs, Steven Pinker, stochastic process, stocks for the long run, superstar cities, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, traveling salesman, trickle-down economics, tulip mania, universal basic income, Watson beat the top human players on Jeopardy!, We are the 99%, yellow journalism, yield curve, Yom Kippur War

Consider a narrative-based chronology of the 2007–9 world financial crisis, which taps into stories about nineteenth-century bank runs that were virtually synonymous with financial crises. After the Great Depression, bank runs were thought to be cured. The Northern Rock bank run in 2007, the first UK bank run since 1866, brought back the old narratives of panicked depositors and angry crowds outside closed banks. The story led to an international skittishness, to the Washington Mutual (WaMu) bank run a year later in the United States, and to the Reserve Prime Fund run a few days after that in 2008. These events then led to the very unconventional US government guarantee of US money market funds for a year. Apparently, governments were aware that they could not allow the old stories of bank runs to feed public anxiety. In the heart of the 2007–9 recession, the Great Depression narrative may have intertwined with bank run narratives to create this popular perception: “We have passed through a euphoric, speculative, immoral period like the Roaring Twenties.

The other would invariably respond, “General who?” The answer was “general prosperity,” referring to McKinley’s words during the campaign. The joke faded in 1897 around a year after the election; it lost its effect when the economy began showing signs of improvement.13 Narratives Trigger the 1893 Bank Runs The 1893–99 depression in the United States started quite suddenly in the spring of 1893 with a string of bank runs. Depositors rushed to pull their money out of banks, thereby fueling the bank failures that they feared. But what triggered the bank run? One trigger was a rumor that began on April 17, 1893: the US subtreasury offices would no longer redeem Treasury notes in gold but would provide only silver, in amounts worth about half as much as the notes. There was no basis for this rumor except the news that Treasury reserves were falling.

Roosevelt also offered moral reasons to spend. Days after his inauguration in 1933, he took the unusual step of addressing the nation by radio during a massive national bank run that had necessitated shutting down all the banks. In this “fireside chat,” he explained the banking crisis and asked people not to continue their demands on banks. He spoke to the nation as a military commander would speak to his troops before a battle, asking for their courage and selflessness. Roosevelt asserted, “You people must have faith. You must not be stampeded by rumors or guesses. Let us unite in banishing fear.”25 The public honored Roosevelt’s personal request. The bank run ended, and money flowed into, not out of, the banks when they reopened. We are still influenced by this narrative constellation. Although the overall narrative has not been powerful enough, or not used well enough, to prevent recessions, it remains in our consciousness and may reassert itself if conditions change.


pages: 310 words: 90,817

Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown by Detlev S. Schlichter

bank run, banks create money, British Empire, business cycle, capital controls, Carmen Reinhart, central bank independence, currency peg, fixed income, Fractional reserve banking, German hyperinflation, global reserve currency, inflation targeting, Kenneth Rogoff, Kickstarter, Long Term Capital Management, market clearing, Martin Wolf, means of production, money market fund, moral hazard, mortgage debt, open economy, Ponzi scheme, price discovery process, price mechanism, price stability, pushing on a string, quantitative easing, reserve currency, rising living standards, risk tolerance, savings glut, the market place, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, Y2K

If money demand has not risen, the additional money will be absorbed via a tendency toward higher prices, that is, a lower purchasing power of the individual monetary unit. The only constraining factor is the overall level of reserves and the risk of a bank run. If too many people ask to exchange their fiduciary media for money proper, any bank will face the risk of running out of reserves. Naturally, this risk increases if the bank is perceived to be in trouble, maybe as a result of problems in its loan portfolio. Once the soundness of a bank is questioned, outflows are likely to accelerate. In a fractional-reserve banking system, and that means today practically every banking system, every bank is potentially at risk of a bank run. A paper money system and a fractional-reserve banking system are confidence-based. Once the confidence goes, the system collapses. This is the real regulating factor of a fractional-reserve banking system, and not demand for money or demand for loans as is often assumed.

As long as confidence is maintained in the soundness of the banking system, the banks can create more money and place this money with the public. They can increase borrowing and therefore overall levels of debt. Today extensive measures have been taken and an elaborate regulatory infrastructure has been erected to reduce the risk of bank runs and to increase the confidence of the public in the soundness of the fractional-reserve banking industry. More importantly, the abandonment of a metallic standard and the adoption of a full paper money system have removed the inelasticity of bank reserves. When banks run low on reserves and face increased outflows (naturally redemptions are no longer in gold but in physical paper money or in the form of transfers to other banks), they can get new reserves from the central bank, which has a lender-of-last-resort function and, under a paper money standard, can create as much reserve money as it wishes “at essentially no cost” (Bernanke).

In the 10 years to the start of the most recent crisis in 2007, bank balance sheets in the United States more than doubled, from $4.7 trillion to $10.2 trillion.3 The Fed’s M2 measure of total money supply rose over the same period from less than $4 trillion to more than $7 trillion.4 From 1996 to 2006, total mortgage debt outstanding in the United States almost tripled, from $4.8 trillion to $13.5 trillion,5 as house prices appreciated, in inflation-adjusted terms, three times faster as over the preceding 100 years.6 Why I Wrote This Book It seems undeniable that elastic money has not brought greater stability. Regarding the stability of money’s purchasing power, the historical record of paper money systems has always been exceptionally poor. But it is now becoming increasingly obvious that the global conversion to paper money has also failed to put an end to bank runs, financial crises, and economic depressions. Quite to the contrary, those crises appear to become more frequent and more severe the longer we use fully elastic money and the more the supply of immaterial money expands. Astonishingly, there is an established body of economic theory that explains with great clarity and precision why this must be the case: the Currency School of the British Classical economists and, in particular, the Austrian School of Economics.


pages: 464 words: 139,088

The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King

"Robert Solow", Andrei Shleifer, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bretton Woods, British Empire, business cycle, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, centre right, collapse of Lehman Brothers, creative destruction, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Doha Development Round, Edmond Halley, Fall of the Berlin Wall, falling living standards, fiat currency, financial innovation, financial intermediation, floating exchange rates, forward guidance, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, German hyperinflation, Hyman Minsky, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, large denomination, lateral thinking, liquidity trap, Long Term Capital Management, manufacturing employment, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Nick Leeson, North Sea oil, Northern Rock, oil shale / tar sands, oil shock, open economy, paradox of thrift, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, quantitative easing, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Satoshi Nakamoto, savings glut, secular stagnation, seigniorage, stem cell, Steve Jobs, The Great Moderation, the payments system, The Rise and Fall of American Growth, Thomas Malthus, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, yield curve, Yom Kippur War, zero-sum game

Four ways have been suggested to deal with this problem. First, banks might suspend withdrawal of deposits in the face of a potential bank run. Banks could just shut their doors for a few days until the crisis has subsided. Of course, for a bank to close its doors, even if only because of a temporary shortage of liquidity, would send a signal that might lead to a loss of confidence on the part of depositors. It might only encourage a run to start sooner than would otherwise be the case, and if suspensions were regarded as potentially likely, then bank deposits would no longer function effectively as money. Second, governments could guarantee bank deposits to remove the incentive to join a bank run. Deposit insurance is now a common feature of most advanced economies’ banking systems. Nevertheless, the insurance provided is not fully comprehensive, and on occasions that has created difficulties.

When the western banking system teetered on the verge of collapse, only drastic intervention, including partial nationalisation, saved it from going over the edge. The potential catastrophe of a collapse finally provoked action to recapitalise the banking system, using public money if necessary; the UK was first to respond, followed by the United States and then continental Europe. That action ended the bank run. The problem was that governments ended up guaranteeing all private creditors of the banks, imposing on future taxpayers a burden of unknown magnitude. Between the autumn of 2008 and the summer of 2009, there was a collapse of confidence and output around the world. World trade fell more rapidly than during the Great Depression of the 1930s. Around ten million jobs were lost in the United States and Europe, almost as many as were employed in US manufacturing prior to the crisis.

As Macheath pointed out in Brecht’s Threepenny Opera, why rob a bank and risk imprisonment when you could start a bank and create money? Both robbers and founders are attracted to banks because that is usually where the money is. But in September 2008 the money wasn’t there. Banks were losing money hand over fist as people who had been willing to lend them large sums suddenly refused to make new loans. Unlike the frequent bank runs in the nineteenth century, when individual depositors occasionally panicked and withdrew their funds, the change of heart had come from other financial institutions, wholesale investors such as money market and hedge funds. Unable to replace these sources of funding, banks had to call in loans, sell assets, and, in some cases, seek funding from their central bank. Before the crisis, banks could borrow at the finest interest rates.


pages: 424 words: 121,425

How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy by Mehrsa Baradaran

access to a mobile phone, affirmative action, asset-backed security, bank run, banking crisis, banks create money, barriers to entry, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, cashless society, credit crunch, David Graeber, disintermediation, disruptive innovation, diversification, failed state, fiat currency, financial innovation, financial intermediation, Goldman Sachs: Vampire Squid, housing crisis, income inequality, Internet Archive, invisible hand, Kickstarter, M-Pesa, McMansion, microcredit, mobile money, moral hazard, mortgage debt, new economy, Own Your Own Home, payday loans, peer-to-peer lending, price discrimination, profit maximization, profit motive, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, Ronald Reagan: Tear down this wall, savings glut, the built environment, the payments system, too big to fail, trade route, transaction costs, unbanked and underbanked, underbanked, union organizing, white flight, working poor

“The mechanic or day laborer who would have a feeling of timidity about entering a big banking house to deposit a small share of his earnings, would gladly avail himself of an opportunity to make the deposit with the local post-master, for the reason that he feels that he has as much right to be there as any other man, for the post-office is a part of the Governmental structure he helps support, and he reckons justly that he is entitled to share in its benefits.”39 The second purpose of general reform was also present from the beginning. Creswell reasoned that the postal banks would cure the bank runs that were endemic to the banking system in the nineteenth century: “The financial difficulties in which the country has been … involved … have demonstrated the necessity for some means of maintaining confidence in times of threatened disaster, and of gathering and wisely employing the immense wealth scattered among the people, to prevent panic and escape the ruin which inevitably follows in its track.”40 Indeed, many bank runs occurred between 1880 and 1910, afflicting both national and state banks and causing nationwide distrust.41 A government-supported bank would go a long way toward infusing trust back into the system.

Even though total deposits didn’t rise during this time, most of the bank failures happened in those midregions, where the deposits did rise the most. When more banks started to fail nationwide, postal savings increased correspondingly. 115. Ibid., 718. 116. Ibid., 710. 117. David Hu, “The Influence of the U.S. Postal Savings System on Bank Runs,” Yale Journal of Economics 2, iss. 1 (2013), accessed March 12, 2015, econjournal.sites.yale.edu/articles/2/influence-us-postal-savings-system-bank-runs. 118. Sissman, “Development of the Postal,” 710. 119. United States Post Office, Annual Report of the Postmaster General, 1935 (Washington, DC: Government Printing Office, 1935), 28. 120. United States Post Office, Annual Report of the Postmaster General, 1941 (Washington, DC: Government Printing Office, 1941), 35. 121.

In order for your $100 to grow into $600, not everyone can ask for their money at the same time—it is not there. A bank only keeps a small reserve to pay out the occasional depositor. This is how banking works but only when people trust banks and allow them to hold on to their money. The only historically proven antidote to fear-induced runs is a government willing to insure bank deposits. Since the inception of deposit insurance, bank runs have been a rare historical phenomenon—so rare that you and I are willing to put all our money in a bank and forget about it. We don’t worry about who manages the bank or what they do with our money. Even if we hear on the news that our bank has started to lend large sums of money to piano-playing cats, which we think is a bad idea, we would not feel the need to show up at the bank the next morning to ask for all of our money back.


pages: 387 words: 119,244

Making It Happen: Fred Goodwin, RBS and the Men Who Blew Up the British Economy by Iain Martin

asset-backed security, bank run, Basel III, beat the dealer, Big bang: deregulation of the City of London, call centre, central bank independence, computer age, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, deindustrialization, deskilling, Edward Thorp, Etonian, Eugene Fama: efficient market hypothesis, eurozone crisis, falling living standards, financial deregulation, financial innovation, G4S, high net worth, interest rate swap, invisible hand, joint-stock company, Kickstarter, light touch regulation, London Whale, Long Term Capital Management, moral hazard, negative equity, Neil Kinnock, Nick Leeson, North Sea oil, Northern Rock, old-boy network, pets.com, Red Clydeside, shareholder value, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, value at risk

Simon & Schuster UK Ltd 1st Floor 222 Gray’s Inn Road London WC1X 8HB www.simonandschuster.co.uk Simon & Schuster Australia, Sydney Simon & Schuster India, New Delhi A CIP catalogue record for this book is available from the British Library ISBN: 978-1-47111-354-3 eBook ISBN: 978-1-47111-356-7 Typeset in the UK by M Rules Printed and bound by CPI Group (UK) Ltd, Croydon, CR0 4YY For Fiona Contents Prologue 1 Tuesday, 7 October 2008 2 Company of Scotland 3 New World 4 Paisley Pattern 5 Battle of the Banks 6 The End of Boom and Bust 7 Fred the Shred 8 Sir Fred 9 Canny Scottish Bankers 10 Safe as Houses 11 Light Touch 12 Double Dutch 13 Bank Run 14 Boom Goes Bust 15 Five Years On Afterword Sources and Acknowledgements Notes Index List of Illustrations Prologue ‘You have a long time to regret it if you don’t get it right.’ Fred Goodwin, 7 June 2004, Businessweek During the boom years, at the beginning of the century, the Royal Bank of Scotland chose an advertising slogan. The words were emblazoned in large letters on billboards at airports, used in television campaigns and appended to mountains of marketing material selling mortgages, insurance and investment products.

Rivalry between the pair had been a significant factor when both charged ahead in 2007 trying to buy the sub-prime-riddled Dutch bank ABN Amro, a race which Goodwin won with disastrous consequences. Now, on the call, Varley and the others turn on Goodwin and start pushing. It is RBS that is the issue; you are the biggest problem. Another old rival is in trouble and is in the middle of being taken over after experiencing its own bank run. Andy Hornby’s crippled HBOS, which contains the old Bank of Scotland, RBS’s Edinburgh rival for almost three centuries, is being bought by the hitherto cautious and conservative Lloyds, run by Eric Daniels. ‘Fred hated the HBOS guys,’ says a friend. ‘He really enjoyed when they had to be taken over by Lloyds and were humiliated. He said: “Good.”’ This unlikely band of brothers, along with the CEOs of the other banks, files into Darling’s office on the second floor at the Treasury at 7.30 p.m. and take seats at the table with their backs to the wall.

The more junior staff the Royal Bank employed were given security and a route for advancement, if they accepted the ethos underpinning a bank embodying self-proclaimed Presbyterian values of hard work, modest behaviour and loyalty. Scottish banking blossomed. Rival outfits opened in Dundee, Ayr, Aberdeen and Perth and banks such as the Bank of Scotland started to develop national networks of branches – another innovation well ahead of England. There were more periodic panics, as there usually are. In 1857 the Western Bank in Glasgow failed spectacularly in the middle of a bank-run. It went down with liabilities of almost £9m. Its shareholders were wiped out. In 1878 there was an even worse disaster when the City of Glasgow Bank folded, following its botched investment in the Racine and Mississippi railroad in America. A difficult situation was exacerbated by extensive fraud on the part of the bank’s management. Amid great public excitement there was a trial, resulting in the imprisonment of the manager and directors.


pages: 571 words: 106,255

The Bitcoin Standard: The Decentralized Alternative to Central Banking by Saifedean Ammous

Airbnb, altcoin, bank run, banks create money, bitcoin, Black Swan, blockchain, Bretton Woods, British Empire, business cycle, capital controls, central bank independence, conceptual framework, creative destruction, cryptocurrency, currency manipulation / currency intervention, currency peg, delayed gratification, disintermediation, distributed ledger, Ethereum, ethereum blockchain, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, George Gilder, global reserve currency, high net worth, invention of the telegraph, Isaac Newton, iterative process, jimmy wales, Joseph Schumpeter, market bubble, market clearing, means of production, money: store of value / unit of account / medium of exchange, moral hazard, Network effects, Paul Samuelson, peer-to-peer, Peter Thiel, price mechanism, price stability, profit motive, QR code, ransomware, reserve currency, Richard Feynman, risk tolerance, Satoshi Nakamoto, secular stagnation, smart contracts, special drawing rights, Stanford marshmallow experiment, The Nature of the Firm, the payments system, too big to fail, transaction costs, Walter Mischel, zero-sum game

The book systematically and methodically avoids ever questioning the causes of the financial crises that have affected the U.S. economy over a century, and instead inundates the reader with impressively researched data, facts, trivia, and minutiae. The central contention of the book is that recessions are the result of the government not responding quickly enough to a financial crisis, bank run, and deflationary collapse by increasing the money supply to re‐inflate the banking sector. It is typical of the Milton Friedman band of libertarianism in that it blames the government for an economic problem, but the flawed reasoning leads to suggesting even more government intervention as the solution. The glaring error in the book is that the authors never once discuss what causes these financial crises, bank runs, and deflationary collapses of the money supply. As we saw from the discussion of the Austrian business cycle theory, the only cause of an economy‐wide recession is the inflation of the money supply in the first place.

A bank that fails is the problem of its shareholders and lenders, and nobody else. Unsound money allows the possibility of mismatching maturity, of which fractional reserve banking is but a subset, and this leaves banks always liable to a liquidity crisis, or a bank run. Maturity mismatching, or fractional reserve banking as a special case of it, is always liable to a liquidity crisis if lenders and depositors were to demand their deposits at the same time. The only way to make maturity mismatching safe is with the presence of a lender of last resort standing ready to lend to banks in case of a bank run.26 In a society with sound money, a central bank would have to tax everyone not involved in the bank in order to bail out the bank. In a society with unsound money, the central bank is simply able to create new money supply and use it to support the bank's liquidity.

Unsound money thus creates a distinction between liquidity and solvency: a bank could be solvent in terms of the net present value of its assets but face a liquidity problem that prevents it from meeting its financial obligations within a certain period of time. But the lack of liquidity itself could trigger a bank run as depositors and lenders seek to get their deposits out of the bank. Worse, the lack of liquidity in one bank could lead to a lack of liquidity in other banks dealing with this bank, creating systemic risk problems. If the central bank credibly commits to providing liquidity in such cases, however, there will be no fear of a liquidity crisis, which in turn averts the scenario of a bank run and leaves the banking system safe. Fractional reserve banking, or maturity mismatching more generally, is likely to continue to cause financial crises without a central bank using an elastic money supply to bail out these banks.


pages: 554 words: 158,687

Profiting Without Producing: How Finance Exploits Us All by Costas Lapavitsas

"Robert Solow", Andrei Shleifer, asset-backed security, bank run, banking crisis, Basel III, borderless world, Branko Milanovic, Bretton Woods, business cycle, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, computer age, conceptual framework, corporate governance, credit crunch, Credit Default Swap, David Graeber, David Ricardo: comparative advantage, disintermediation, diversified portfolio, Erik Brynjolfsson, eurozone crisis, everywhere but in the productivity statistics, financial deregulation, financial independence, financial innovation, financial intermediation, financial repression, Flash crash, full employment, global value chain, global village, High speed trading, Hyman Minsky, income inequality, inflation targeting, informal economy, information asymmetry, intangible asset, job satisfaction, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, liberal capitalism, London Interbank Offered Rate, low skilled workers, M-Pesa, market bubble, means of production, money market fund, moral hazard, mortgage debt, Network effects, new economy, oil shock, open economy, pensions crisis, price stability, Productivity paradox, profit maximization, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, race to the bottom, regulatory arbitrage, reserve currency, Robert Shiller, Robert Shiller, savings glut, Scramble for Africa, secular stagnation, shareholder value, Simon Kuznets, special drawing rights, Thales of Miletus, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, total factor productivity, trade liberalization, transaction costs, union organizing, value at risk, Washington Consensus, zero-sum game

Carlo Panico, for instance, partly in debate with Ben Fine, treats bank costs as a necessary input that must earn profits. This is an erroneous approach to the intermediary role of banks. 47 Lapavitsas, Social Foundations of Markets, Money and Credit, ch. 4. 48 Bank runs are fairly rare events in the history of mature capitalism, though the crisis of the 2000s has lent renewed relevance to this phenomenon. Mainstream theory is fully aware of the ineluctable risk of bank runs given the normal practices of commercial banking; see Douglas Diamond and Philip Dybvig, ‘Bank Runs, Deposit Insurance and Liquidity’, Journal of Political Economy 91, 1983. 49 The idea of 100% reserves for banks, or ‘narrow banking’, is associated with the Chicago tradition in economics. It represents the goldsmiths view of banking taken to an extreme limit; for a brief discussion see n. 33 in Chapter 10. 50 Lapavitsas, Social Foundations of Markets, Money and Credit, ch. 4. 51 Kozo Uno, Keizai Seisakuron, Tokyo: Kobundo Shobo, 1936, part 3, ch. 1, section 2. 52 This point escapes the new financial economics which treats the emergence of financial institutions as the result of market failure – that is, of the inability to have equilibrating give-and-take between owners and users of funds.

Traditional banking stands in contrast to securitized banking; the former is the business of making and holding loans, with insured demand deposits as the main source of funds; the latter is the business of packaging and reselling loans, with repurchase agreements as the main source of funds. In this light, the financial crisis of 2007–2008 was a system-wide bank run which, however, did not occur in the traditional but in the securitized banking sector. While a traditional bank run amounts to the mass withdrawal of deposits, a securitized bank run amounts to the mass withdrawal of repurchase agreements (repos). The cause of the run was concern about the liquidity of the bonds used as collateral for repos, particularly when these bonds were related to the subprime market. The result was that the US financial system became insolvent since it could not service its debts.

Townsend, ‘Optimal Contracts and Competitive Markets with Costly State Verification’, Journal of Economic Theory 22, 1979. 9 See, for instance, Joseph Stiglitz and Andrew Weiss, ‘Credit Rationing in Markets with Imperfect Information’, American Economic Review 71:3, 1981, pp. 393–410; Nobuhiro Kiyotaki and John Moore, ‘Credit Cycles’, Journal of Political Economy 105:2, 1997. 10 Once again, the literature is very broad; see, very selectively, Hayne Leland and David H. Pyle, ‘Informational Asymmetries, Financial Structure and Financial Intermediation’, The Journal of Finance 32, 1977; John Bryant, ‘A Model of Reserves, Bank Runs, and Deposit Insurance’, Journal of Banking and Finance 4, 1980; Douglas Diamond and Philip Dybvig, ‘Bank Runs, Deposit Insurance and Liquidity’, Journal of Political Economy 91, 1983; Douglas Diamond, ‘Financial Intermediation and Delegated Monitoring’, Review of Economic Studies 51, 1984; John H. Boyd and Edward C. Prescott, ‘Financial Intermediary-Coalitions’, Journal of Economic Theory 38, 1986; Douglas Diamond and Raghuram Rajan, ‘Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking’, Journal of Political Economy 109:2, 2001; Franklin Allen and Anthony M.


pages: 246 words: 74,341

Financial Fiasco: How America's Infatuation With Homeownership and Easy Money Created the Economic Crisis by Johan Norberg

accounting loophole / creative accounting, bank run, banking crisis, Bernie Madoff, Black Swan, business cycle, capital controls, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Brooks, diversification, financial deregulation, financial innovation, helicopter parent, Home mortgage interest deduction, housing crisis, Howard Zinn, Hyman Minsky, Isaac Newton, Joseph Schumpeter, Long Term Capital Management, market bubble, Martin Wolf, Mexican peso crisis / tequila crisis, millennium bug, money market fund, moral hazard, mortgage tax deduction, Naomi Klein, new economy, Northern Rock, Own Your Own Home, price stability, Ronald Reagan, savings glut, short selling, Silicon Valley, South Sea Bubble, The Wealth of Nations by Adam Smith, too big to fail

Since investors themselves did not know what the packages contained, the "Aaa" label was what gave them their value. And now it turned out that most of them had been mislabeled. As if on command, investors stopped buying mortgage-backed securities. All the financial institutions and special companies whose business model was to take out short-term credit to keep their trade in securities going discovered that they could no longer renew their loans. It was a bank run. As it concerned the shadow banking sector, it did not involve actual crowds of depositors rushing to the bank to get their savings out before everybody else did, but the mechanism and the effect of causing the bank to go belly-up in the process were the same. All the special companies, conduits, and structured investment vehicles filled to the brim with mortgage-backed securities that the banks had placed off their balance sheets depended on regularly being able to renew short-term loans of maybe $1 billion, $10 billion, or $30 billion for maturities ranging from as much as nine months to as little as 24 hours.

Banks were forced to make huge commitments, and the law required them to hoard capital to cover those commitments, but the market was in no lending mood. In just a few moments, a stable bank could seem to be teetering on the brink of insolvency. Citigroup saw its balance sheet grow by $49 billion in a single day in December 2007. There was no other way out for the banks but to pull the emergency brake so that they could build up more capital, and several of them also started borrowing directly from the Fed. The drawn-out bank run can be said to have begun on August 9, 2007. That was when the French bank BNP Paribas took the unusual step of preventing investors from withdrawing money from three money-market funds invested in U.S. mortgagebacked securities. Only one week earlier, its head had made assurances that the bank's exposure to the subprime crisis was absolutely negligible, but now BNP explained that the collapse in prices made it impossible to assess the value of the funds.

Citigroup's Charles Prince (the man who stood accused of being unable to tell a CDO from a shopping list) found out for the first time at a board meeting in September 2007 that his bank was sitting on $43 billion in various types of mortgage-backed securities. He asked the person responsible whether this was a problem and was told that no major losses could be expected. Only two months later, however, the bank estimated its subprime losses at $10 billion. Prince chose to step down-taking $38 million in bonuses, stocks, and options with him. In September 2007, the United Kingdom was hit by a classic bank run taking place on real streets and squares. In scenes that the country had not witnessed for over 140 years, long lines of worried depositors wanting to withdraw their money were forming outside the branch offices of Northern Rock. This Newcastle bank had derived two-thirds of its financing from money-market loans, capable of being canceled at any time, and used the money for decadelong securitized mortgages whose value exceeded that of the actual homes.16 As Martin Wolf has concluded, government guarantees for the banking system meant that savers saw only the high rates of interest paid by Northern Rock, not the risks it was taking.


pages: 363 words: 107,817

Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed by Andrew Jackson (economist), Ben Dyson (economist)

bank run, banking crisis, banks create money, Basel III, Bretton Woods, business cycle, call centre, capital controls, cashless society, central bank independence, credit crunch, David Graeber, debt deflation, double entry bookkeeping, eurozone crisis, financial exclusion, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, Hyman Minsky, inflation targeting, informal economy, information asymmetry, intangible asset, land reform, London Interbank Offered Rate, market bubble, market clearing, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, negative equity, Northern Rock, price stability, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, risk-adjusted returns, seigniorage, shareholder value, short selling, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, unorthodox policies

Accordingly, banks no longer needed to worry about the three C’s: “When you securitize mortgage you don’t care about the risk, because you’re going to pass it off”. (Davidson, 2008) The ability to securitise loans means banks can make profits not by the quality of the loans they make, but by their quantity. The willingness of banks to lend to the subprime market was partially (and possibly predominantly) attributable to securitisation. Government guarantees & ‘too big to fail’ “Bank runs are a common feature of the extreme crises that have played a prominent role in monetary history. During a bank run, depositors rush to withdraw their deposits because they expect the bank to fail. In fact, the sudden withdrawals can force the bank to liquidate many of its assets at a loss and to fail. During a panic with many bank failures, there is a disruption of the monetary system and a reduction in production.” (Diamond & Dybvig, 1983) When a company becomes insolvent, creditors to that company will usually lose a proportion of their money.

Staying liquid Banks also run the risk of becoming insolvent through being unable to meet their liabilities as they fall due, even though their assets may be greater than their liabilities. In accounting terms, this is known as cashflow insolvency. In banking jargon it is reffered to as a ‘liquidity crisis’. A liquidity crisis can happen if there is a significant outflow of funds (central bank reserves) from a bank to other banks or to customers who are withdrawing cash. This process can happen very quickly, as in a bank run, or slowly if its liabilities are withdrawn slightly faster than its loan assets are repaid. If a bank becomes unable to settle its liabilities to either customers or to other banks, then it is again declared insolvent and will need to cease trading. Avoiding a liquidity crisis relies on a process known as ‘asset liability management’, which involves managing and predicting inflows and outflows to ensure that a bank is always able to make its payments as and when it needs to.

A liquidity ratio is similar, but allows banks to hold highly-liquid assets such as government bonds in place of cash and central bank reserves, with the idea being that bonds can easily be exchanged for cash and central bank reserves if customers are making higher than usual withdrawals from their accounts. In short, liquidity ratios and reserve ratios say, “What percentage of customers could withdraw their deposits simultaneously before the bank runs out of base money?” A reserve ratio or liquidity ratio of 10% would imply that the bank could suffer a withdrawal of up to 10% of its deposits before it would become illiquid and have to close its doors. In contrast, the capital or ‘capital reserves’ that are required by the Basel Capital Accords relate to the assets side of the balance sheet. Capital requirements say, in essence, “What percentage of our loans can default before we become insolvent?”


pages: 272 words: 64,626

Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs by Andy Kessler

23andMe, Andy Kessler, bank run, barriers to entry, Berlin Wall, Bob Noyce, British Empire, business cycle, business process, California gold rush, carbon footprint, Cass Sunstein, cloud computing, collateralized debt obligation, collective bargaining, commoditize, computer age, creative destruction, disintermediation, Douglas Engelbart, Eugene Fama: efficient market hypothesis, fiat currency, Firefox, Fractional reserve banking, George Gilder, Gordon Gekko, greed is good, income inequality, invisible hand, James Watt: steam engine, Jeff Bezos, job automation, Joseph Schumpeter, Kickstarter, knowledge economy, knowledge worker, libertarian paternalism, low skilled workers, Mark Zuckerberg, McMansion, Netflix Prize, packet switching, personalized medicine, pets.com, prediction markets, pre–internet, profit motive, race to the bottom, Richard Thaler, risk tolerance, risk-adjusted returns, Silicon Valley, six sigma, Skype, social graph, Steve Jobs, The Wealth of Nations by Adam Smith, transcontinental railway, transfer pricing, wealth creators, Yogi Berra

One of the roles of the Federal Reserve is the lender of last resort, which they unfortunately learned after the stock market crash of 1929 and the bank runs that followed. Ten thousand banks failed, roughly 40 percent, and $2 billion in deposits were wiped out—30 percent of the money supply disappeared. So did a similar percentage of GDP, and unemployment hit 25 percent. You can see that lost money supply is not a good thing. So the other big change happened twenty years later, in 1933. The Federal Deposit Insurance Corporation (FDIC) was set up to insure depositors’ money, negating the desire for people to line up to get their money out at the first sign of a bank’s weakness. No more bank runs. Not many, anyway. (We can argue about whether the FDIC is really an insurance policy, as they undercharge banks for the privilege of insuring against bank runs, and you and I, the taxpayers, make up the difference.

(We can argue about whether the FDIC is really an insurance policy, as they undercharge banks for the privilege of insuring against bank runs, and you and I, the taxpayers, make up the difference. Still, the FDIC is a decent bargain. It’s a backstop to panics—bank run panics anyway!) As long as banks make prudent loans, which, as we’ve seen in 2008, is not the greatest assumption. Twin bargains. Twin safety nets for fractional reserve banking so we don’t have to go back to the stifling days of gold. The Federal Reserve allows banks to post assets in exchange for loans to redeem depositors, in effect making the Fed the lender of last resort to banks. And then there’s the FDIC, basically an insurance policy (up to $100,000 and sometimes $250,000) against bank runs, no matter how bad the bankers are at making loans. And who said banks are private companies? All of this still means the Federal Reserve has to figure out exactly how much money to create to fill the bucket representing population growth and productivity—an almost impossible task.

They might as well lend out ten times as much money as the gold held, figuring not all “depositors” would want their gold back at the same time. Money from nothing (and your checks for free). Sort of, anyway. This sleight of hand is called fractional reserve banking, and was an easy (if not a little sleazy, no?) way to increase money supply to, again, make room for productivity and wealth creation. But how much money? No one knows, which is why there were occasionally bank runs and panics and depressions that followed easy credit, one of the hazards of this flimsy system. Sixteen panics since 1812—it’s as American as apple pie! But banking did increase money supply beyond just how much gold could be extracted. In fact, since Adam and Eve, 160,000 tons of gold have been panned and mined from Mother Earth, enough to fill two Olympic-sized swimming pools. At $35 per ounce under the old gold standard, that comes to $180 billion in value, not nearly enough to support all the value created by entrepreneurs.


pages: 249 words: 66,383

House of Debt: How They (And You) Caused the Great Recession, and How We Can Prevent It From Happening Again by Atif Mian, Amir Sufi

"Robert Solow", Andrei Shleifer, asset-backed security, balance sheet recession, bank run, banking crisis, Ben Bernanke: helicopter money, break the buck, business cycle, Carmen Reinhart, collapse of Lehman Brothers, creative destruction, debt deflation, Edward Glaeser, en.wikipedia.org, financial innovation, full employment, high net worth, Home mortgage interest deduction, housing crisis, Joseph Schumpeter, Kenneth Rogoff, Kickstarter, liquidity trap, Long Term Capital Management, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, quantitative easing, Robert Shiller, Robert Shiller, school choice, shareholder value, the payments system, the scientific method, tulip mania, young professional, zero-sum game

If the value of banking assets falls, spooked depositors may all demand their money when they sense the bank is in trouble—a bank run. Bank runs can lead to even healthy banks going under. For example, even a depositor in a healthy bank will “run” if he believes that other depositors are withdrawing their funds in a panic. The run dynamic is dangerous. It forces banks to sell assets at prices below market value. It can also damage the payment system of a country, which relies on bank deposits: when someone writes a check, it is cleared by shifting deposits from one bank to another. Businesses often pay their workers from deposit accounts. If the value of bank deposits is called into question, the entire payment system of a country may break down. It is a well-accepted axiom of banking regulation that the central bank must act as a “lender of last resort” to prevent bank runs. It can do so by explicitly insuring bank deposits, as the Federal Deposit Insurance Corporation (FDIC) does, or by lending freely to liquidity-constrained banks.

See also housing boom of 2000–2007 asset price collapses, 42–45, 70 austerity measures, 163 auto industry: sales rates in, 5–6; unemployment in, 61–62, 64–65 Bagehot Rule, 124 balance sheet recession, 194n5 bank bailouts, 121–34, 142, 151; FDIC loans in, 124; Federal Reserve programs in, 124–26, 154–57; protection of deposits in, 123–26, 129; protection of stakeholders in, 126–27, 131–34; Troubled Asset Relief Program (TARP) as, 136 bank crises, 7–9, 192n20; bank runs in, 123–26; current-account deficits in, 7–8; government protections in, 92–93, 119–29; household debt in, 8–9; IMF loans in, 92–95; real estate prices in, 7; short-term financing instruments in, 125; Spanish bankruptcy law and, 119–21, 184–85; stakeholders in, 121–23; stress in, 129, 130f. See also the Depression; Great Recession bank-lending view, 10–11, 31–35, 127–34; inflation in, 153–62; lowered interest rates in, 52–53; political power and, 131–34; refutation of, 127–30; risk-taking in, 177–78; small business concerns of, 128; unemployment in, 128–30 Bank of England, 162 bank reserves, 154–57, 160 bank runs, 123–26 bankruptcy, 119–23, 202n37, 203n44; mortgage cram-downs and, 146–48; student loans and, 167 behavioral biases view, 90–91, 197n18 Beim, David, 4–6 Ben-David, Itzhak, 139 Bender, Stefan, 69 Benson, Clea, 133–34 Bernanke, Ben, 78, 127, 132–33, 153, 157 Biden, Joseph, 146 Blinder, Alan, 193n1 borrowers: consumer spending of, 55, 140–42; declining income growth of, 79–80, 90; deflation and, 152–53; expansion of mortgage credit to, 75–91, 164–65; forgiveness practices for, 60, 135–51, 205n19; home equity loans of, 20, 86–91, 159; junior claims of, 18–19, 50; in the levered-losses framework, 50–52, 70–71, 134, 158–59, 170; lowered interest rates and, 52–53; as marginal borrowers, 76–80, 103–5, 198n18; moral hazard and, 149–51, 206n13; net worth of, 50.

If a bank’s short-term liabilities were all demanded at once, it would not be able call back the money it has lent out on a long-term basis. In other words, the mismatch in maturity makes banks vulnerable to a run. Even if a bank is fundamentally solvent, a run can make its failure self-fulfilling. A central bank can prevent self-fulfilling banking crises by providing liquidity (i.e., cash) to a bank to protect it from bank runs. Just the ability of a central bank to flood banks with cash may be sufficient to prevent runs from happening in the first place, because depositors then have faith that their money is protected. In the East Asian crisis, however, central banks couldn’t flood the banks with cash because it needed to be in U.S. dollars. Without the ability to print dollars, these central banks watched helplessly as the domestic banks and corporate sector went bankrupt as foreign investors fled.


pages: 436 words: 98,538

The Upside of Inequality by Edward Conard

affirmative action, Affordable Care Act / Obamacare, agricultural Revolution, Albert Einstein, assortative mating, bank run, Berlin Wall, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Climatic Research Unit, cloud computing, corporate governance, creative destruction, Credit Default Swap, crony capitalism, disruptive innovation, diversified portfolio, Donald Trump, en.wikipedia.org, Erik Brynjolfsson, Fall of the Berlin Wall, full employment, future of work, Gini coefficient, illegal immigration, immigration reform, income inequality, informal economy, information asymmetry, intangible asset, Intergovernmental Panel on Climate Change (IPCC), invention of the telephone, invisible hand, Isaac Newton, Jeff Bezos, Joseph Schumpeter, Kenneth Rogoff, Kodak vs Instagram, labor-force participation, liquidity trap, longitudinal study, low skilled workers, manufacturing employment, Mark Zuckerberg, Martin Wolf, mass immigration, means of production, meta analysis, meta-analysis, new economy, offshore financial centre, paradox of thrift, Paul Samuelson, pushing on a string, quantitative easing, randomized controlled trial, risk-adjusted returns, Robert Gordon, Ronald Reagan, Second Machine Age, secular stagnation, selection bias, Silicon Valley, Simon Kuznets, Snapchat, Steve Jobs, survivorship bias, The Rise and Fall of American Growth, total factor productivity, twin studies, Tyler Cowen: Great Stagnation, University of East Anglia, upwardly mobile, War on Poverty, winner-take-all economy, women in the workforce, working poor, working-age population, zero-sum game

.* It briefly guaranteed $15 trillion of deposits, loaned the banks $2 trillion to fund withdrawals, and made a profit.8 The Fed made a profit acting as the lender of last resort in the worst financial crisis in nearly a millennium. The Fed took surprisingly little risk despite an avalanche of reckless claims to the contrary. Rather than strengthening the Fed’s ability to act more effectively as the lender of last resort in a bank run, policy makers have done the opposite. They have held banks more responsible for bank runs by intentionally weakening the Fed’s ability to act in a panic. Banks pulled back lending by raising credit standards. Risk-averse savings have subsequently sat unused, and the recovery has been anemic. Other well-intentioned policies would have the same effect. Demanding that banks hold more equity largely just reallocates risk-taking from other sectors of the economy.

More valuable on-the-job training, large synergistic communities of experts, highly motivated and trained talent, and equity in the hands of eager risk-takers had compounding effects on the value of successful risk-taking. I recommended lower marginal tax rates to maintain higher payoffs in the face of slower growth in the aftermath of the financial crisis. The Obama administration did the opposite. I cautioned that holding the banks responsible for bank runs, instead of just loan losses, at a time when they were already reluctant to lend, would slow growth. I recommended strengthening government guarantees of banks and the Fed’s ability to function as the lender of last resort but charging banks and borrowers for these guarantees. The Obama administration did the opposite. Most Keynesian economists insisted that the government need only borrow and spend idle savings to create growing demand.

That might be the case if risk underwriters had let equity sit idle to compensate for the risk of government guarantees of banks that lure risk-averse savings from their mattresses. After all, taxpayers bear those risks. But why would equity dial back risk-taking in the face of government guarantees of banks? The government made a profit loaning banks $2 trillion to fund withdrawals and making $15 trillion of guarantees (to stop further withdrawals) during the worst bank run since the 1930s.30 How concerned should risk-bearing taxpayers be about the risk of government guarantees? While it is true that, to a certain extent, bank guarantees also guarantee loan losses, one way or another the economy already bears that risk. Government guarantees of banks don’t change that. Besides, it’s easy to assess and assign loan loss to lenders, as long as we don’t try to do it in the thick of the crisis.


pages: 460 words: 122,556

The End of Wall Street by Roger Lowenstein

Asian financial crisis, asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, break the buck, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, fixed income, high net worth, Hyman Minsky, interest rate derivative, invisible hand, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, Rubik’s Cube, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

Similar arguments applied to deregulation of airlines, trucking, and other industries. Even in financial markets, some slackening of the rules was appropriate—as in, for instance, the liberalization that permitted interstate banking. But deregulators made two mistakes. One was failing to recognize that financial markets were more fragile than others, more vulnerable to panics and, indeed, more vital to the economy overall. Airline failures are rarely front-page news; bank runs are. The other mistake was failing to see that the relative financial stability of the postwar era was largely a result of the regulation put in place during the New Deal and after. With the turn toward market-driven economies in the 1980s, it was thought that markets had outgrown the ancient perils that arise from speculative frenzy, excessive borrowing, and greed—when in fact, Washington had been holding them in check.

The Chinese held more than $500 billion of GSE debt—presumably, more than they could sell—but this only heightened the pressure on Paulson to protect Fannie’s and Freddie’s credit.15 If the agencies failed, a run on Treasuries (the government’s paper) would follow. As Fannie’s and Freddie’s stocks were being battered, trouble was flaring at IndyMac, the Pasadena bank spun off from Countrywide. IndyMac, which had specialized in Alt-A loans, had been left holding thousands of shaky mortgages when the securitization market shut down. From late June to early July, Indy was hit with a bank run. Depositors withdrew $1.3 billion, about $100 million a day. On July 11, two months after the bank’s chairman, Michael Perry, had assured investors that his company was well capitalized, the Office of Thrift Supervision seized Indy—the second biggest bank to fail in U.S. history, trailing only Continental Illinois in 1984. IndyMac’s collapse socked the FDIC with an astronomical $10.7 billion in insurance costs, and enraged Sheila Bair, FDIC’s chairwoman. 16 She resolved that regulators would move sooner, and more aggressively, against weak banks in the future.

Premiums for Goldman, a perfectly solvent firm, surged from a negligible sum to $150,000.6 Some of this was rational; the risk had increased. But credit was effectively being rationed by rank speculators. Worse, some of those purchasing “insurance” were short-sellers with an interest in seeing insurance prices soar. Because rising prices in the swap market were contagious, they contributed to fears of systemic weakness. They were not unlike the bank runs that fed the gloom of the 1930s. A junior Lehman executive, reflecting on rising swap rates, the pressure from short-sellers, and tightening credit conditions in general, sensed “the world falling apart.” The deepening woes of Fannie and Freddie further darkened the mood at Lehman—as did the nonstop articles speculating on the firm’s demise, which felt to AIG’s Willumstad like a tourniquet suffocating his company, too.


pages: 311 words: 99,699

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe by Gillian Tett

accounting loophole / creative accounting, asset-backed security, bank run, banking crisis, Black-Scholes formula, Blythe Masters, break the buck, Bretton Woods, business climate, business cycle, buy and hold, collateralized debt obligation, commoditize, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, easy for humans, difficult for computers, financial innovation, fixed income, housing crisis, interest rate derivative, interest rate swap, Kickstarter, locking in a profit, Long Term Capital Management, McMansion, money market fund, mortgage debt, North Sea oil, Northern Rock, Renaissance Technologies, risk tolerance, Robert Shiller, Robert Shiller, Satyajit Das, short selling, sovereign wealth fund, statistical model, The Great Moderation, too big to fail, value at risk, yield curve

Within minutes of the BBC bulletin, consumers began logging on to Northern Rock’s website and withdrawing their cash. The website then crashed, fueling panic. The next morning, Northern Rock savers flocked to the bank’s branch offices, and pictures of terrified savers in a long line in front of the bank beamed onto computers, television screens, BlackBerries, and mobile phones around the world. By midmorning, a full-scale bank run was under way. Never before had so many terrified consumers and investors seen a bank run in action, in real time. Technology was helping to spread the panic. What brought Northern Rock down was another variant of the woes that had beset IKB and Cairn. At the turn of the century, the bank had embraced securitization with a vengeance, raising funds by selling masses of mortgage-backed bonds to investors all over the world. By 2007, less than a quarter of Northern Rock’s funding came from retail deposits, with the rest raised by securitization.

HG6024.U6T48 2009 332.660973—dc22 2009005127 ISBN-13: 978-1-4391-0075-2 ISBN-10: 1-4391-0075-6 Visit us on the Web: http://www.SimonandSchuster.com For Helen and Analiese CONTENTS PREFACE PART 1: INNOVATION 1 THE DERIVATIVES DREAM 2 DANCING AROUND THE REGULATORS 3 THE DREAM TEAM 4 THE CUFFS COME OFF 5 MERGER MANIA PART 2: PERVERSION 6 INNOVATION UNLEASHED 7 MR. DIMON TAKES CHARGE 8 RISKY BUSINESS 9 LEVERAGING LUNACY 10 TREMORS PART 3: DISASTER 11 FIRST FAILURES 12 PANIC TAKES HOLD 13 BANK RUN 14 BEAR BLOWS UP 15 FREE FALL EPILOGUE NOTES GLOSSARY ACKNOWLEDGMENTS ABOUT THE AUTHOR PREFACE Were the bankers mad? Were they evil? Or were they simply grotesquely greedy? To be sure, there have been plenty of booms and busts in history; market crashes are almost as old as the invention of money itself. But this crisis stands out due to its sheer size; economists estimate that total losses could end up being $2 trillion to $4 trillion.

That made Western investment banks eager to court the IKB officials. At the ESF conference in Barcelona, for example, American brokers and City bankers swarmed around the Germans, in the hope of selling them more bonds. However, as Winters stood in Geneva International in July, it was clear that something had gone badly wrong with the IKB funds. He called his traders in London. “What’s going on?” he asked. “There’s something like a bank run starting in the commercial paper markets,” a trader replied. That news was alarming. Until that point, the commercial paper market had been deemed one of the safest, and dullest, corners of the financial world. It was where General Electric and other blue-chip giants raised the short-term funds that they needed for day-to-day operations. It was also where solid, risk-averse investors tended to put their cash as an alternative to placing their money on deposit at a bank.


pages: 430 words: 109,064

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

American ideology, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, break the buck, business cycle, buy and hold, capital controls, Carmen Reinhart, central bank independence, Charles Lindbergh, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Gordon Gekko, greed is good, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

Bear Stearns was brought down by a modern-day bank run.13 On a proportional basis, it was more exposed to structured mortgage-backed securities than its rivals, and it was also highly dependent on short-term funding—cash that came from very short-term borrowing, much of it overnight.14 This meant that its creditors could refuse to roll over their loans from one day to the next and demand their money back instead. If that happened, there was no way Bear could pay them back, since many of its assets were illiquid; structured securities can be hard to sell on short notice, and selling them under pressure would cause their prices to collapse. If some creditors thought that this might happen, they would try to get their money out first, which would provoke other creditors to do the same, triggering a bank run as everyone scrambled to avoid being last in line.

The Glass-Steagall Act separated commercial banking from investment banking to prevent commercial banks from being “infected” by the risky activities of investment banks. (One theory at the time—since largely discredited—was that this infection had weakened commercial banks and helped cause the Depression.)100 As a result, J.P. Morgan was forced to spin off its investment banking operations, which became Morgan Stanley. Commercial banks were protected from panic-induced bank runs by the Federal Deposit Insurance Corporation (FDIC), but had to accept tight federal regulation in return. The governance of the Federal Reserve was also reformed in the 1930s, strengthening the hand of presidential appointees and weakening the relative power of banks. The system that took form after 1933, in which banks gained government protection in exchange for accepting strict regulation, was the basis for half a century of financial stability—the longest in American history.

As the long boom of the 1990s continued and the stock market continued to go up, LTCM soon faded into memory. U.S. policymakers did draw a number of important lessons from the emerging market crises, outlined by Treasury Secretary Larry Summers in a major lecture at the 2000 conference of the American Economics Association.51 Financial crises were the result of fundamental policy weaknesses: “Bank runs or their international analogues are not driven by sunspots: their likelihood is driven and determined by the extent of fundamental weaknesses.” It was more important to look at the soundness of the financial system than to simply count the total amount of debt: “When well-capitalized and supervised banks, effective corporate governance and bankruptcy codes, and credible means of contract enforcement, along with other elements of a strong financial system, are present, significant amounts of debt will be sustainable.


pages: 1,066 words: 273,703

Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze

Affordable Care Act / Obamacare, Apple's 1984 Super Bowl advert, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, Boris Johnson, break the buck, Bretton Woods, BRICs, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, dark matter, deindustrialization, desegregation, Detroit bankruptcy, Dissolution of the Soviet Union, diversification, Doha Development Round, Donald Trump, Edward Glaeser, Edward Snowden, en.wikipedia.org, energy security, eurozone crisis, Fall of the Berlin Wall, family office, financial intermediation, fixed income, Flash crash, forward guidance, friendly fire, full employment, global reserve currency, global supply chain, global value chain, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, housing crisis, Hyman Minsky, illegal immigration, immigration reform, income inequality, interest rate derivative, interest rate swap, Kenneth Rogoff, large denomination, light touch regulation, Long Term Capital Management, margin call, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, mittelstand, money market fund, moral hazard, mortgage debt, mutually assured destruction, negative equity, new economy, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shale / tar sands, old-boy network, open economy, paradox of thrift, Peter Thiel, Ponzi scheme, predatory finance, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, reserve currency, risk tolerance, Ronald Reagan, savings glut, secular stagnation, Silicon Valley, South China Sea, sovereign wealth fund, special drawing rights, structural adjustment programs, The Great Moderation, Tim Cook: Apple, too big to fail, trade liberalization, upwardly mobile, Washington Consensus, We are the 99%, white flight, WikiLeaks, women in the workforce, Works Progress Administration, yield curve, éminence grise

But it wasn’t until September 13, after the BBC reported the story and the government acted to address the crisis by announcing a guarantee, that the retail depositors panicked. After that, the main damage to Northern Rock’s balance sheet was done by online withdrawals. The elderly savers queuing in the streets made for alarming TV footage. But it was not their panic that was bringing down the bank. It was a bank run operating on an altogether different scale at the speed of computer terminals in money markets across the world. It was a bank run without deposit withdrawals. There had been no deposits. There was nothing to withdraw. For banks to find themselves a trillion dollars short, all that needed to happen was for major providers of funding to withdraw from the money markets. The Rise and Fall of Commercial Paper and Repo Financing, 2004–2014 Source: Tobias Adrian, Daniel Covitz and Nellie Liang, “Financial Stability Monitoring,” Annual Review of Financial Economics 7 (2015): 357–395, chart 15.

As Hyun Song Shin, chief economist at the Bank for International Settlements and one of the foremost thinkers of the new breed of “macrofinance,” has put it, we need to analyze the global economy not in terms of an “island model” of international economic interaction—national economy to national economy—but through the “interlocking matrix” of corporate balance sheets—bank to bank.22 As both the global financial crisis of 2007–2009 and the crisis in the eurozone after 2010 would demonstrate, government deficits and current account imbalances are poor predictors of the force and speed with which modern financial crises can strike.23 This can be grasped only if we focus on the shocking adjustments that can take place within this interlocking matrix of financial accounts. For all the pressure that classic “macroeconomic imbalances”—in budgets and trade—can exert, a modern global bank run moves far more money far more abruptly.24 What the Europeans, the Americans, the Russians and the South Koreans were experiencing in 2008 and the Europeans would experience again after 2010 was an implosion in interbank credit. As long as your financial sector was modestly proportioned, big national currency reserves could see you through. That is what saved Russia. But South Korea struggled, and in Europe, not only were there no reserves but the scale of the banks and their dollar-denominated business made any attempt at autarkic self-stabilization unthinkable.

But the really decisive break in market confidence came on the morning of August 9, 2007, when BNP Paribas, France’s most prominent bank, announced that it was freezing three of its funds.5 The explanation Paribas offered marked a decisive moment in the opening of the crisis: “The complete evaporation of liquidity in certain market segments of the U.S. securitisation market has made it impossible to value certain assets fairly regardless of their quality or credit rating.”6 Without valuation the assets could not be used as collateral. Without collateral there was no funding. And if there was no funding all the banks were in trouble, no matter how large their exposure to real estate. In a general liquidity freeze, the equivalent of a giant bank run, no bank was safe. As the implications of the announcement from Paris sank in, around noon Central European Time on August 9, 2007, the cost of borrowing on European interbank markets surged.7 As one senior bank executive commented, the event was disorientating: “It was something none of us had experienced. It was as if your entire life you had turned the spigot and water came out. And now there was no water.”8 The ECB did not at this point have data on the subprime exposure of Europe’s banks.


The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis by Tim Lee, Jamie Lee, Kevin Coldiron

active measures, Asian financial crisis, asset-backed security, backtesting, bank run, Bernie Madoff, Bretton Woods, business cycle, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, debt deflation, distributed ledger, diversification, financial intermediation, Flash crash, global reserve currency, implied volatility, income inequality, inflation targeting, labor-force participation, Long Term Capital Management, Lyft, margin call, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, negative equity, Network effects, Ponzi scheme, purchasing power parity, quantitative easing, random walk, rent-seeking, reserve currency, rising living standards, risk/return, sharing economy, short selling, sovereign wealth fund, Uber and Lyft, uber lyft, yield curve

The Federal Reserve was created in the years following the Panic of 1907 in an effort to bring stability to a domestic banking system that was beset with recurring financial panics and bank runs. The international monetary system—the use of gold as a single global currency—was also changed around the same time by political choices made in response to the economic necessities of World War I. Neither the domestic banking system nor the gold standard worked for society, and so they were themselves changed. This process of change was neither discrete, nor uncontroversial, nor even initially successful. The Federal Reserve System did not end bank runs; that required more political decisions, specifically the establishment of deposit insurance and effective bank supervision in 1933. The international system continued to adjust as well, first with failed attempts to return to gold, followed by the managed dollar-centric system of Bretton Woods, and followed eventually by the mostly open system of global capital flows we have today.

Index Page numbers followed by f indicate figures; t indicate tables. anti-carry crashes, 170 anti-carry regimes, 165, 171–172, 210, 212 carry regime similarities to, 173–175 monetary perspective on, 168–170 signs of end of, 215 AQR Capital, 79 arbitrage, covered interest parity principle and, 21 Asian financial crisis, 23–25 global financial crisis compared with, 30 asset prices business cycle and, 126 carry regime and, 204 distortion of, 7 inflation of, 113–114 options and, 147 recessions and declines in, 6 assets under management (AUM), 74 by sovereign wealth funds, 75 Australia capital inflows, 40, 40f, 42 credit and net claims, 40, 40f credit growth, 40f, 41 interest rate spreads and, 41–42, 60–61 Australian dollar, 30 capital flows into, 62 returns on, 97, 97f bailouts, 197–199, 203 Bain and Company, 80 balance of payments, Turkey, 45 Bank for International Settlements (BIS), 15, 17, 22 carry portfolio position comparison with, 63, 63t on corporate use of carry strategies, 80 currency liquidity data, 62 net claims data, 41 Bank of Japan (BOJ), 26, 216 quantitative easing policies by, 31 Bank of Korea, 197 bank runs, 218 banking system, money creation by, 109 bank-run dynamics, 65 Bhattacharya, Utpal, 142 bid-ask spread, 158–159, 167 big breaks, 184 BIS. See Bank for International Settlements BOJ. See Bank of Japan Brazil, 19, 39, 55n6, 65–66 current account, 31 Brazilian real, 11, 30, 66 Bretton Woods system, 218 Brownian noise, 97, 97f Bruno, Valentina, 80–81 bubble-boom economies, carry bubble conditions and, 39 business cycle carry and global, 2 carry bubbles and, 127–134 carry crashes and, 127–134 carry influence on, 57, 69 carry regime and, 125–127 money supply and, 125–126 Caballero, Ricardo, 59 call options, 146–147 Cambridge Associates, 79 capital asset pricing model, 99 Capital in the Twenty-First Century (Piketty), 219 221 222 capital inflows, Australia, 40, 40f, 42 capitalism, 195, 219, 220 carry central banks’ role in, 5–8 compensation incentives for, 70–72 corporate use of, 80–83 as cumulative advantage, 181–184 defining, 2 as flow from weak to strong, 179–181 global business cycle and, 2 hedge funds as agents of, 72–73 insidious structural aspects of, 200–205 leverage importance to, 70–72 lost opportunity to lean against, 220 as luck compounded, 184–186 monetary policy and, 3 as naturally occurring phenomenon, 88 necessary amounts of, 174 omnipresence of, 190–191 as power, 191–192 as rent-seeking, 175–177 rise of, 1 volatility, 86 carry bubbles, 6, 7 business cycle and, 127–134 credit bubbles and, 37–38, 41 credit demand and, 114 disguised, 134–140 economic indicators distorted by, 44–45 economic problems obscured by, 44 inflation and, 39 monetary conditions and, 39 nonmonetary assets and, 169 Ponzi schemes and, 140–143 as risk mispricing, 142 Turkey, 42–46 carry crashes, 6 Asian financial crisis and, 23–25 bailouts limiting losses from, 203 business cycle and, 127–134 carry trade returns and, 36 deflation and, 7, 170 deflation shock and, 121–124 in emerging economies, 201 incentive changes and, 84 inevitability of, 34–35, 108 leverage and, 96–98 liquidity and, 128 money supply and, 122–123 INDEX of 1998, 25–26 Turkey, 42–46 Turkish lira, of 2018, 45 of 2008, 30, 31 Volmageddon, 98, 161 yen melt-up and, 23–24 carry portfolios backtesting, 65–67 BIS data comparison with, 63, 63t constructing, 49–50 lessons from historical study of, 64–65 losses in, 51–56, 54f carry regime, 2 anti-carry regime similarity to, 173–175 asset prices and, 204 business cycle and, 125–127 central bank policies and, 86–89, 107, 208, 210 central bank power and, 123 central banks and collapses of, 215–216 central banks weakened by, 7 debt levels and, 168 defining, 107–108 deflation and, 113–121, 203, 210, 213 development of, 127, 134 economic growth and, 209 economic imbalances from, 201 financial market structure and, 7 fragility of, 201 monetary equilibrium and, 169 monetary growth and, 169 monetary perspective on, 168–170 money in, 108–113 nonmonetary assets and, 112, 114, 122 resource allocation and, 114–115 risk mispricing and, 134–140 S&P 500 importance to, 86–87, 87f theoretical alternative to, 166–168 vanishing point and, 116, 195, 209–210 volatility signs of ending, 214–218 carry trade.

In particular, since the use of leverage means that even modest changes in position value can translate into a total loss of capital, risk controls will force trades to be closed when certain thresholds are hit. Risk controls can come from internal limits and can also be forced upon managers by lenders who require additional collateral to be posted to cover losses. In either case it is very easy for a “bank-run” dynamic to take place—losses lead to position reduction, forcing managers to trade into markets that are moving against them and, in the case of many emerging currencies, are illiquid. This activity triggers further losses, which require even more position reduction, and the cycle continues until moves in the exchange rate are so extreme that unlevered traders are induced to enter the market or central banks are forced to intervene to stabilize conditions.


pages: 708 words: 196,859

Lords of Finance: The Bankers Who Broke the World by Liaquat Ahamed

Albert Einstein, anti-communist, bank run, banking crisis, Bretton Woods, British Empire, business cycle, capital controls, central bank independence, centre right, credit crunch, currency manipulation / currency intervention, Etonian, full employment, German hyperinflation, index card, invisible hand, Lao Tzu, large denomination, Long Term Capital Management, margin call, market bubble, Mexican peso crisis / tequila crisis, mobile money, money market fund, moral hazard, new economy, open economy, plutocrats, Plutocrats, price stability, purchasing power parity, pushing on a string, rolodex, the market place

The central banks had powerful tools to deal with these outbursts—specifically their authority to print currency and their ability to marshal their large concentrated holdings of gold. But for all of this armory of instruments, ultimately the goal of a central bank in a financial crisis was both very simple and very elusive—to reestablish trust in banks. Such breakdowns are not some historical curiosity. As I write this in October 2008, the world is in the middle of one such panic—the most severe for seventy-five years, since the bank runs of 1931-1933 that feature so prominently in the last few chapters of this book. The credit markets are frozen, financial institutions are hoarding cash, banks are going under or being taken over by the week, stock markets are crumbling. Nothing brings home the fragility of the banking system or the potency of a financial crisis more vividly than writing about these issues from the eye of the storm.

Officials at the Bronx branch tried to convince the exigent depositor that he should hold on to his stock, that even at current prices it remained an excellent investment. No doubt irritated at this obvious attempt to renege on a clear promise, he stormed out and began reporting that the bank was in trouble. By the afternoon, a small horde of depositors had begun lining up outside the branch’s tiny neoclassical limestone building to withdraw their savings before closing time. Until now, despite the Depression, there had been no bank runs in New York, and soon a crowd of twenty thousand curious bystanders had gathered to watch. As the anxious depositors became restless, a squad of mounted police had to be sent in to control them and several customers were arrested; and when the mob became frantic, the police charged the crowd with their horses. The Bank of United States had fifty-seven branches across the four larger boroughs of New York, and over four hundred thousand individual depositors, more than any other bank in the country.

He would testify later that “I told them that the Bank of United States occupied a rather unique position in New York City, that in point of people served it was probably the largest bank in the city and that its closing might affect a large number of smaller banks and that I was afraid that it would be the spark that would ignite the whole city.” Broderick reminded the grandees that only two or three weeks before “they had rescued two of the largest private bankers in the city.” One of them was Kidder Peabody, an investment bank run by Boston Brahmins, founded in 1865, which as result of the crash and of subsequent withdrawals of deposits by, among others, the government of Italy, had had to be bailed out in 1930 with $15 million from J. P. Morgan and Chase. Though the meeting continued into the early hours of the morning, he was unable to persuade the few recalcitrants to change their mind. The Fed, believing that it could throw a ring fence around the BUS and prevent its troubles from spreading, decided to close the bank’s doors the next morning.


pages: 381 words: 101,559

Currency Wars: The Making of the Next Gobal Crisis by James Rickards

Asian financial crisis, bank run, Benoit Mandelbrot, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, borderless world, Bretton Woods, BRICs, British Empire, business climate, buy and hold, capital controls, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Fall of the Berlin Wall, family office, financial innovation, floating exchange rates, full employment, game design, German hyperinflation, Gini coefficient, global rebalancing, global reserve currency, high net worth, income inequality, interest rate derivative, John Meriwether, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, Network effects, New Journalism, Nixon shock, offshore financial centre, oil shock, one-China policy, open economy, paradox of thrift, Paul Samuelson, price mechanism, price stability, private sector deleveraging, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, Ronald Reagan, sovereign wealth fund, special drawing rights, special economic zone, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, time value of money, too big to fail, value at risk, War on Poverty, Washington Consensus, zero-sum game

When Knickerbocker’s involvement in the scheme came to light, a classic run on the bank commenced. If the Knickerbocker revelations had occurred in calmer markets, they might not have triggered such a panicked response, but the market was already nervous and volatile after massive losses caused by the 1906 San Francisco earthquake. The failure of the Knickerbocker Trust was just the beginning of a more general loss of confidence, which led to another stock market crash, even further bank runs, and finally a full-scale liquidity crisis and threat to the stability of the financial system as a whole. This threat was stemmed only by collective action of the leading bankers of the day in the form of a private financial rescue organized by J. P. Morgan. In one of the most famous episodes in U.S. financial history, Morgan summoned the financiers to his town house in the Murray Hill neighborhood of Manhattan and would not allow them to leave until they had hammered out a rescue plan involving specific financial commitments by each one intended to calm the markets.

Leading English banks had made leveraged investments in illiquid assets funded with short-term liabilities, exactly the type of investing that destroyed Lehman Brothers in 2008. As those liabilities came due, foreign creditors converted their sterling claims into gold that soon left England headed for the United States or France or some other gold power not yet feeling the full impact of the crisis. With the outflow of gold becoming acute and the pressures of the bank run threatening to destroy major banks in the City of London, England went off the gold standard on September 21, 1931. Almost immediately sterling fell sharply against the dollar and continued dropping, falling 30 percent in a matter of months. Many other countries, including Japan, the Scandinavian nations and members of the British Commonwealth, also left the gold standard and received the short-run benefits of devaluation.

In November 1932, Franklin D. Roosevelt was elected president to replace Herbert Hoover, whose entire term had been consumed by a stock bubble, a crash and then the Great Depression itself. However, Roosevelt would not be sworn in as president until March 1933, and in the four months between election and inauguration the situation deteriorated precipitously, with widespread U.S. bank failures and bank runs. Millions of Americans withdrew cash from the banks and stuffed it in drawers or mattresses, while others lost their entire life savings because they did not act in time. By Roosevelt’s inauguration, Americans had lost faith in so many institutions that what little hope remained seemed embodied in Roosevelt himself. On March 6, 1933, two days after his inauguration, Roosevelt used emergency powers to announce a bank holiday that would close all banks in the United States.


pages: 290 words: 84,375

China's Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle by Dinny McMahon

2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, American Society of Civil Engineers: Report Card, Andrei Shleifer, Asian financial crisis, bank run, business cycle, California gold rush, capital controls, crony capitalism, dark matter, Deng Xiaoping, Donald Trump, Edward Glaeser, eurozone crisis, financial innovation, fixed income, Gini coefficient, if you build it, they will come, income inequality, industrial robot, invisible hand, megacity, money market fund, mortgage debt, new economy, peer-to-peer lending, Ponzi scheme, Ronald Reagan, short selling, Silicon Valley, too big to fail, trickle-down economics, urban planning, working-age population, zero-sum game

So far, the People’s Bank of China has proved extremely accommodating to ensure that there is. But what if, suddenly, there weren’t? Financial crises aren’t caused by bad loans. Much like a conventional bank run, crises occur when people, en masse, no longer believe that their money is safe, and so they rush to pull it out of wherever it’s invested. The reason they lose faith might be that they’re worried that a bank has too many bad loans, but it’s the act of withdrawing the funds that undermines the viability of a bank, or the entire financial system. In its simplest form, such a loss of faith manifests itself as a bank run, as in the Jimmy Stewart movie It’s a Wonderful Life, where the sight of people queuing up outside a bank branch leads others to do the same, draining the bank of its cash reserves until it can no longer satisfy depositors’ demands for their money back.

In its simplest form, such a loss of faith manifests itself as a bank run, as in the Jimmy Stewart movie It’s a Wonderful Life, where the sight of people queuing up outside a bank branch leads others to do the same, draining the bank of its cash reserves until it can no longer satisfy depositors’ demands for their money back. But China has grown quite adept at dealing with conventional runs. In 2014, two rural banks in Jiangsu Province experienced a bank run that lasted for three days after a number of local underground financiers and unregulated loan shops collapsed, making people jittery about whether the local banks were exposed to the same problems. The People’s Bank of China rushed money to the branches. The bricks of freshly delivered cash were stacked up behind the tellers in order to calm nerves. The modern, more dangerous version of the bank run happens when the trust between banks themselves breaks down and they decline to continue lending to each other. That’s what caused Lehman Brothers to collapse in 2008 and plunged the U.S. financial system into crisis.

(7.2% of the U.S. economy): “Overview,” Financial Services Spotlight, Select‑USA, https://www.selectusa.gov/financial-services-industry-united-states. wealth-management products: Ambrose Evans-Pitchard, “China Losing Control as Stocks Crash Despite Emergency Measures,” The Telegraph, July 27, 2015, http://www.telegraph.co.uk/finance/china-business/11766449/China-losing-control-as-stocks-crash-despite-emergency-measures.html. to calm nerves: John Ruwitch, “How Rumor Sparked Panic and Three-Day Bank Run in Chinese City,” Reuters, March 26, 2014, http://www.reuters.com/article/us-china-banking-idUSBREA2P02H20140326. falling any further: Gabriel Wildau, “China’s ‘National Team’ Owns 6% of Stock Market,” Financial Times, November 25, 2015, https://www.ft.com/content/7515f06c-939d-11e5-9e3e-eb48769cecab. “such a big loss”: Ibid. “feeling the squeeze”: Dinny McMahon, “Lack of Local Lending Sinks Chinese Company’s Pakistan Deal,” Wall Street Journal, November 5, 2014, http://www.wsj.com/articles/china-textile-maker-cancels-pakistan-acquisition-deal-as-local-banks-wont-lend-1415192513.


pages: 576 words: 105,655

Austerity: The History of a Dangerous Idea by Mark Blyth

"Robert Solow", accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, Black Swan, Bretton Woods, business cycle, buy and hold, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, deindustrialization, disintermediation, diversification, en.wikipedia.org, ending welfare as we know it, Eugene Fama: efficient market hypothesis, eurozone crisis, financial repression, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, Gini coefficient, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, information asymmetry, interest rate swap, invisible hand, Irish property bubble, Joseph Schumpeter, Kenneth Rogoff, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, Long Term Capital Management, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Occupy movement, offshore financial centre, paradox of thrift, Philip Mirowski, price stability, quantitative easing, rent-seeking, reserve currency, road to serfdom, savings glut, short selling, structural adjustment programs, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, unorthodox policies, value at risk, Washington Consensus, zero-sum game

It would be hugely impractical for big businesses to truck in enormous amounts of cash every weekend to pay their employees out of retained earnings held at their local bank. So companies borrow and lend money to each other over very short periods at very low interest rates, typically swapping assets for cash and then repurchasing those assets the next day for a fee—hence “sale” and “repurchase”—or “repo.” It is cheaper than borrowing from the local bank and doesn’t involve fleets of armored trucks. What happened in 2007 and 2008 was a bank run through this repo market.5 A bank run occurs when all the depositors in a bank want their cash back at the same time and the bank doesn’t have enough cash on hand to give it to them. When this happens, banks either borrow money to stay liquid and halt the panic or they go under. The repo market emerged in the 1980s when traditional banks lost market share because of a process called “disintermediation.”6 Banks, as intermediaries, traditionally sit in the middle of someone else’s prospective business, connecting borrowers and lenders, for example, and charging fees for doing so.

Again, I stress that these are quintessentially private-sector phenomena. I do this so that I can ask one more question as a setup. If all the trouble was generated in the private sector, why do so many people blame the state for the crisis and see cuts to state spending as the way out of a private-sector mess? Answering that question is what concerns us in the rest of this chapter. The Generator: Repo Markets and Bank Runs The repo market is a part of what is called the “shadow banking” system: “shadow,” since its activities support and often replicate those of the normal banks, and “banking” in that it provides financial services to both the normal (regulated) banks and the real economy. Take paychecks, for example. It would be hugely impractical for big businesses to truck in enormous amounts of cash every weekend to pay their employees out of retained earnings held at their local bank.

This had the effect of reversing the flow of capital to Europe as US capital came home to take advantage of these higher interest rates, which unexpectedly further stoked the stock market boom.15 After all, why put your money in Germany when you can make 15 percent buying shares in an investment trust and 7 percent in a bank deposit in the USA? The resulting capital flight placed enormous pressure on the German economy, which responded with ever-stricter austerity policies, especially, as we shall see, under Chancellor Brüning in 1930–1931. Deprived of external liquidity—all the money had gone back to the United States—bank runs in Austria and Germany were met with ever-tighter austerity policies in exchange for more loans (that failed to materialize) to stave off the inevitable default. Eventually, and tragically, as loans dried up tariffs rose, currencies were devalued, and the postwar recession became the Great Depression. Beyond this overview of why austerity failed on a macro level, what is of most interest to us here is how different countries’ austerity policies fared on a micro level during this crisis.


pages: 258 words: 71,880

Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street by Kate Kelly

bank run, buy and hold, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Donald Trump, fixed income, housing crisis, index arbitrage, Long Term Capital Management, margin call, moral hazard, quantitative hedge fund, Renaissance Technologies, risk-adjusted returns, shareholder value, technology bubble, too big to fail, traveling salesman

Noon Thursday Minutes before noon, Bear managers gathered in the twelfth-floor boardroom for a scheduled meeting of the Presidential Advisory Committee, a group of forty or so top managers who advised Bear’s senior brass on business matters and strategy. The day’s presentations included a talk by the trader who handled Bear’s commercial mortgage-backed securities. But in order to address “the environment,” as the e-mailed update had put it, Schwartz was added to the speaking roster at the last minute. No one paid much attention to the presentations until it was Schwartz’s turn to talk. Despite the looming bank run, the CEO appeared uncannily relaxed. Leaning back in his chair, he dismissed the chatter around Bear’s cash position, reasoning that companies like General Motors had faced similar rumor-mongering in the past that had turned out to be nothing but “noise.” Bear would come out all right, he told the group, and the key was to stay focused on the day-to-day business. But in the middle of his speech, Schwartz was interrupted by an angry Mike Minikes, the executive who ran the firm’s prime-brokerage business, where hedge funds kept their money for trading.

Now they were hoping, one last time, that the government would make an exception. It was their only hope for survival. Bernanke addressed the subject of bankruptcy. “Can they open for business if they file?” he asked. Not in New York State, was the answer. The implications of Bear’s travails were hitting the Fed chairman hard. It was possible, he thought, to be adequately capitalized under securities laws and still face a bank run. Even if federal regulators thought you looked okay, in other words, you could still be out of business overnight. A scholar of the Great Depression, Bernanke’s thoughts turned to Credit-Anstalt, the Austrian bank that had gone bankrupt in 1931. Hoping to stabilize their teetering economy by giving confidence to bank customers, the country’s central bankers had guaranteed Credit-Anstalt’s deposits—assuring the public that even if the bank went out of business, the government would ensure that they didn’t lose their savings.

“People realized that Bear Stearns just came out the other day saying everything was fine,” Paul Nolte, director of investments at the small firm Hinsdale Associates, told the Dow Jones Newswires. “So, two days later, why would they need this funding from the Fed and J.P. Morgan? If it’s like that for them, what is it like for Merrill Lynch or for Thornburg Mortgage?” By then the Federal Reserve Board had gathered in its headquarters in the Foggy Bottom section of Washington and approved the emergency loan. Bernanke and his colleagues hated the thought of financing a bank run with government dollars, but they knew that helping Bear survive the day would be better than allowing it to collapse. The vote was unanimous. LATER FRIDAY March 14, 2008 10:00 A.M. Calls were pouring in to Bear’s investor-relations and financial divisions. Sequestered in his office on the sixth floor, Molinaro could hardly keep up with his phone messages. He was being slammed with questions from Bear’s investors, all of who were wondering what the Fed facility meant for the stock.


pages: 261 words: 103,244

Economists and the Powerful by Norbert Haring, Norbert H. Ring, Niall Douglas

"Robert Solow", accounting loophole / creative accounting, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, bank run, barriers to entry, Basel III, Bernie Madoff, British Empire, buy and hold, central bank independence, collective bargaining, commodity trading advisor, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, diversified portfolio, financial deregulation, George Akerlof, illegal immigration, income inequality, inflation targeting, information asymmetry, Jean Tirole, job satisfaction, Joseph Schumpeter, Kenneth Arrow, knowledge worker, law of one price, light touch regulation, Long Term Capital Management, low skilled workers, mandatory minimum, market bubble, market clearing, market fundamentalism, means of production, minimum wage unemployment, moral hazard, new economy, obamacare, old-boy network, open economy, Pareto efficiency, Paul Samuelson, pension reform, Ponzi scheme, price stability, principal–agent problem, profit maximization, purchasing power parity, Renaissance Technologies, rolodex, Sergey Aleynikov, shareholder value, short selling, Steve Jobs, The Chicago School, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, ultimatum game, union organizing, Vilfredo Pareto, working-age population, World Values Survey

In the euro area, the minimum reserve requirement was cut from an already ridiculous rate of 2 percent to 1 percent in January 2012, and in the UK it has long been abolished altogether such that British banks can decide for themselves how much cash and central bank reserves they want to keep as a safety margin to satisfy customers’ demand for cash. The reserve requirement determines how much the banks can expose themselves – or in practice, the public purse – to the risk of a bank run. The lower the reserves in proportion to the money that customers could withdraw at any time, the higher the risk of a bank run. This does not only affect the banks with the lowest reserves. If the reserve requirement is low, the banking system as a whole has low reserves in relation to potential withdrawals of cash. This is why the problems of any significant bank routinely threaten to put the entire financial system at risk. If customers of one bank get worried that they might not get their money back, customers of all other banks have reason to run to their bank before others have the same idea.

In fact, the first bank that failed at the start of the subprime crisis in 2007 was the small German bank IKB. The government rescued it, at great cost to taxpayers, based on the argument that a bank failure would damage the public’s trust in the banking system. As government-sponsored depositor insurance systems, central banks and the prospect of bailout packages in times of need insure the banks against a bank run, a low reserve requirement is a superb MONEY IS POWER 83 deal for private banks. Using their influence, they made sure that in Europe minimum reserve requirements were continuously reduced in the last decades of the twentieth century. In the US, they engineered policies so that the reserve requirement would cover less and less of the financial sector’s money creation activities. The goal of the operation was usually cast as improving the international competitiveness of the banks of the respective nations or as increasing the attractiveness of the respective financial centers.

He also set up a bank in New York to benefit from the privileged position of a central reserve city bank as well as several national banks, either personally or through his associates. Chase’s successor Hugh McCulloch extended Cooke’s monopoly. He was a close friend of Cooke’s. When McCulloch left the Treasury, he became head of Cooke’s London office. The result of the new system was a great expansion of the number of banks and of deposits but also, in short order, a series of financial crises. There were panics and bank runs in 1873, 1884, 1893 and 1907 (Rothbard 1985/2008). As a reaction to these crises, the Federal Reserve System was created in 1913 upon bankers’ initiative. At a secret meeting at Jekyll Island, Georgia in December 1910, they hammered out the essential features of the new Federal Reserve System. Bankers representing the interests of Rockefeller, J.P. Morgan and Kuhn, Loeb & Company, the most powerful institutions of the time, dominated the meeting.


Firefighting by Ben S. Bernanke, Timothy F. Geithner, Henry M. Paulson, Jr.

Asian financial crisis, asset-backed security, bank run, Basel III, break the buck, Build a better mousetrap, business cycle, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Doomsday Book, financial deregulation, financial innovation, housing crisis, Hyman Minsky, income inequality, invisible hand, Kenneth Rogoff, labor-force participation, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, pets.com, price stability, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, savings glut, short selling, sovereign wealth fund, special drawing rights, The Great Moderation, too big to fail

It’s why traditional bank architecture relied so heavily on imposing granite facades and pillars to project an aura of stability and permanence in front of the fragility of finance. No financial institution can function without confidence, and confidence is evanescent. It can go at any time, for rational or irrational reasons. When it goes, it usually goes quickly, and it’s hard to get back. A financial crisis is a bank run writ large, a crisis of confidence throughout the system. People get scared and want their money back, which makes the money remaining in the system less safe, which makes more people want their money back, a self-reinforcing doom loop of fear, fire sales, capital shortfalls, margin calls, and credit contractions that can produce a stampede for the exits. Once a stampede begins, it becomes rational to run to avoid getting trampled, and hesitation can be deadly.

You might have to sell the asset immediately to avoid default, and if others with similar assets hold similar fire sales, the price of the assets will drop further, triggering more fire sales and margin calls and defaults, and so on down the drain. If you happen to be a financial firm, your creditors might sour on your commercial paper, stop renewing your overnight repo loans, or force you to post more collateral, the modern equivalents of bank runs. That’s how panic spread after the housing bubble popped. Before the crisis of 2008, many large financial institutions were increasingly leveraged, in some cases borrowing more than $30 for every dollar of shareholder capital, affording very limited protection against losses. Increasing amounts of that leverage were in short-term debt that resembled uninsured bank deposits, the kind of runnable debt that uneasy creditors can withdraw at the first hint of danger.

The Fed poured in a further $62 billion by buying Treasuries and issued a statement encouraging banks to borrow from the discount window. Even those textbook initial steps were criticized as too much too soon. Bank of England governor Mervyn King called out the ECB and the Fed for overreacting to blips in the markets. A month later, the Bank of England would provide similar liquidity after his country’s first bank run in 150 years. Inside the Fed, several Federal Open Market Committee (FOMC) members wanted to attach harsh conditions to discount window loans to avoid moral hazard. But Ben and Tim didn’t want to add to the stigma the banks already associated with Fed loans. We didn’t want banks to stay away from the discount window; we wanted them to take the Fed’s money and lend it out. The general infusion of liquidity helped bring some calm to the markets, but even without onerous conditions, the Fed’s come-and-get-it message did not attract banks to the discount window.


pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, break the buck, Bretton Woods, business cycle, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy, zero-sum game

That should limit unrest as well as reducing the currency collapse and inflationary upsurge. In either case, a big challenge would be to manage the contagion. An exit, particularly a disorderly one, would surely trigger bank runs and capital flight from other members. It could also cause collapses in the prices of financial and other assets. A flight to safety, to Germany or beyond the Eurozone, would occur. A decisive response from the Eurozone would be required to halt the contagion. The ECB would need to act as a lender of last resort on an unlimited scale, replacing money taken out in bank runs. Interest rates on sovereign debt would need to be capped. Above all, the commitment to keep the rest of the Eurozone together would have to be reinforced. The Eurozone either is an irrevocable currency union or it is not.

The programme for Cyprus had two significant features: for the first time, it imposed losses on bank creditors, notably including depositors (100 per cent losses on amounts above €100,000 in the now closed Laiki Bank and 60 per cent losses on amounts over €100,000 in the larger Bank of Cyprus), many of whom were, not coincidentally, foreign, particularly Russian; and, no less important, it inflicted controls on transfers of euros outside the country. It became even clearer than before that some euros were more equal than others. A euro deposited in a dodgy bank backed by a weak sovereign was and is not the same as a euro deposited in a solid bank supported by a strong sovereign.18 This makes the Eurozone structurally vulnerable to bank runs, since it obviously makes sense to move accounts from banks backed by weak sovereigns to banks backed by creditworthy ones, particularly at a time of crisis. It is also why informed observers concluded that some kind of banking union was essential if the Eurozone was to survive in the long run. In 2011 a far more significant event occurred than this set of crises in small countries. Spain and Italy, two far larger economies, fell into similar financial difficulty, a remarkably dangerous turn of events.

By external balance, we mean that the economy has a sustainable external position – net trade or net capital flows (these just being two sides of the accounts, since net inflows of capital finance current-account deficits): a sustainable deficit is one that can be financed on affordable terms indefinitely. If the required net inflow of foreign financing is too large, financing will become increasingly expensive and may stop altogether, possibly suddenly. That is what happened to Greece in 2010, as was noted in Chapter Two above. A ‘sudden stop’ is the consequence of a collective decision by investors that deficits are indeed unsustainable: a stop has the characteristics of a bank run, since the decision by individual investors to withdraw funding is triggered by the perception that others are doing so. ‘Sustainability’ is, therefore, ultimately a subjective, not an objective, phenomenon. As Hamlet tells us, ‘There is nothing either good or bad, but thinking makes it so.’ Unfortunately and crucially, external sustainability is asymmetrical. It is possible for a country to run a large current-account surplus and so accumulate net claims on the rest of the world virtually without limit.


pages: 543 words: 147,357

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, Bretton Woods, business cycle, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, liberal capitalism, light touch regulation, Long Term Capital Management, Louis Pasteur, low cost airline, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, Mikhail Gorbachev, millennium bug, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, plutocrats, Plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, Satyajit Das, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, working poor, zero-sum game, éminence grise

Britain and the United States had presided over the creation of a twenty-first-century banking system that had all the characteristics of unregulated commercial banking in the nineteenth century. Almost inevitably, the consequence was the same: a series of terrifying bank runs. This time, though, it was not ordinary savers stampeding to withdraw their cash: it was professionals and institutions, who moved much more quickly, violently and vastly. Bankers joke that retail customers are more likely to divorce their partner than switch their bank, and it takes the imminent threat of catastrophe to make them flood to the cashiers to withdraw their deposits. Professionals have always been much more trigger-happy. The blight that hit Northern Rock, the American investment banks, RBS and HBOS – and very nearly did for both Citigroup and Bank of America – was nothing less than a nineteenth-century-style bank run in the twenty-first-century wholesale markets. It happened for all the same reasons and had the same threat of contagion from bad banks to good.22 The system had grown gargantuan, with a scale of borrowing short to lend long on assets of dubious quality that was mind-boggling.

An IMF paper reports that young people growing up in recessions are much more fatalistic than others, believing that effort and work are far less important in generating results than having the luck to live in good times.7 Bank crashes can even damage health directly. A study at Cambridge University found that they increase the risk of death from stress and worry.8 The customers who tried to withdraw cash from Northern Rock, Britain’s first bank run for more than a century, experienced a similar level of stress to victims of an earthquake. The capitalism that Britain developed and which crashed so spectacularly has a lot to answer for. To date, though, it has hardly even been asked any questions, let alone provided any answers. A wounded society The unbalanced structure of economic growth over the last decade has fed straight through to a disastrous social geography, bypassing the least advantaged and rewarding the wealthy.

If every depositor simultaneously asked for their money back, the bank would have to recall every loan, but some of the creditors would certainly be unable to pay immediately, which would leave the bank insolvent. In reality, though, all depositors will not ask for their money back simultaneously, because they will not all need it at once. This assumption is the foundation of banking. However, should depositors lose confidence in a bank’s capacity to meet their demands, they may well all try to withdraw their money at the same time. This is what happens in a bank run. Banks are therefore pulled two ways: to be ultra-conservative in order to maintain depositors’ confidence, and the tremendous financial temptation, and commercial pressure, to be less conservative. If they can build up a position of leveraged lending to a portfolio of borrowers, especially in a class of assets that are appreciating in value, there are fortunes to be made for both financiers and their shareholders.


pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, business cycle, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, John Meriwether, Kickstarter, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, Mitch Kapor, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sam Peltzman, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, survivorship bias, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

If depositors incorrectly think that a bank is in trouble, their deposit withdrawals will create a bank run and push even a very healthy bank toward failure.45 On March 6, 1933, U.S. President Franklin D. Roosevelt called for a “bank holiday” and closed every bank in the country. They remained closed until Department of the Treasury officials could inspect each institution’s ledgers. Banks in viable financial condition were primed with Treasury money and permitted to do business again. Those in marginal condition were kept closed until they could be restored to soundness. Numerous banks that had been poorly run remained closed forever. This was one way to stop the endless cycle of banking system destruction. The Federal Deposit Insurance Corporation (FDIC) was one regulatory response to the bank runs of the 1930s. Established in the Banking Act of 1933, it insured bank deposits so that depositors would not worry about losing their savings to bank failures.46 Investment banks do not have this guarantee on their customer deposits.

Paulson did not call Brown, but did call Chancellor of the Exchequer Alistair Darling. This deal, and perhaps a deal with another suitor, would have been much more likely had the U.S. guaranteed it. 45. Mozilo, Countrywide’s CEO, pointed to a Los Angeles Times article that caused depositor panic. The next day depositors withdrew $8 billion from the bank. In nine days, depositors withdrew $16.7 billion, forcing the bank out of business. 46. This didn’t prevent bank runs in 2008, partly because many depositors had more than the $100,000 account limit and partly because, even with the guarantee, people were nervous or didn’t understand the rules. The FDIC subsequently raised the account limit to $250,000. 47. Transparent, stress-tested financial statements detailing Lehman’s exposure would have helped a great deal in the weeks leading up to Lehman’s collapse. For instance, financial statements could have contained scenario tests, such as the effects on Lehman’s portfolio if real estate prices drop by 30% in all of markets and subsequent defaults are 10%.

January and February are typically good for fixed-income relative-value funds, because banks window-dress their balance sheets near the fiscal year’s end in November and December.2 The housing crisis made 2008 an exception. JWMP started the year with its worst-ever monthly return: −4.14% in January 2008. February was even worse, at −5.25%. By the end of February, JWMP began to unwind some of its risk. The Bear and the Gorilla Attack Then came the institutional bank run on Bear Stearns in March 2008. Bear Stearns, a major prime broker and liquidity provider for hedge funds, was heading for bankruptcy. Dimon and J.P. Morgan bought it at the fire sale price of $2 per share.3 That month, JWMP lost 24.8% of its fund, a loss that was eight times more than its previous worst monthly loss. Even with a new, more conservative risk management system, the LTCM crew was getting pulverized again.


pages: 484 words: 136,735

Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis by Anatole Kaletsky

"Robert Solow", bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, bonus culture, Bretton Woods, BRICs, business cycle, buy and hold, Carmen Reinhart, cognitive dissonance, collapse of Lehman Brothers, Corn Laws, correlation does not imply causation, creative destruction, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, F. W. de Klerk, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, global rebalancing, Hyman Minsky, income inequality, information asymmetry, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kickstarter, laissez-faire capitalism, Long Term Capital Management, mandelbrot fractal, market design, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage debt, Nelson Mandela, new economy, Northern Rock, offshore financial centre, oil shock, paradox of thrift, Pareto efficiency, Paul Samuelson, peak oil, pets.com, Ponzi scheme, post-industrial society, price stability, profit maximization, profit motive, quantitative easing, Ralph Waldo Emerson, random walk, rent-seeking, reserve currency, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, statistical model, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, Vilfredo Pareto, Washington Consensus, zero-sum game

It was after Paulson turned up at the Senate Banking Committee on the morning of September 23 and proved unable to explain his inchoate roundabout scheme that the worst of the bank runs started. Within a week of this fiasco Congress had voted down the first attempt at TARP funding, triggering the biggest-ever daily fall on Wall Street in terms of points, Washington Mutual had collapsed, the HBOS-Lloyds merger had effectively unraveled, threatening the failure of Britain’s entire financial system, all the banks in Iceland had been nationalized, and the German government had been forced to throw a €35 billion ($50 billion) lifeline to Hypo RE, the country’s biggest commercial property lender. With each passing day, the panic spread to new countries and new institutions, but there was nothing irrational about it. The series of bank runs that almost destroyed the world economy were perfectly reasonable responses to the self-destructive actions of the U.S.

First and foremost, he or she would realize that at a time of crisis all banks depend on some kind of implicit guarantee, from the government or from a quasi-public institution. Because no bank has enough ready cash to repay its depositors if they all decide simultaneously to withdraw their funds, there are only two ways to restore confidence among depositors once they start worrying about the loss of their money in a bank run. Either the bank must be able to raise a large amount of capital quickly to prove to its depositors that it remains solvent, or the depositors must be offered an unconditional guarantee from another institution whose solvency is beyond question. When an individual bank suffers, takeover by a bigger institution is often enough. But with a run on the entire banking system, the only plausible guarantors are the government, which can tax the whole nation, or the central bank, which can print money without limit to back its guarantees.19 Paulson inadvertently closed off both of these escape routes in the days just before and after September 15.

Through financial misjudgments motivated largely by a naïve faith in free markets, Paulson eliminated the possibility of any U.S. financial institution raising additional private capital. Then, partly through ideological dogmatism and partly political timidity, he ruled out the only viable alternative, which was temporarily to offer all American banks unlimited government guarantees. The almost inevitable result was a run on every major bank and financial institution, first in America and then around the world. And after this generalized bank run had started, the only possible outcome was the ideological U-turn that occurred in the week of October 6, 2008, when the Irish, Greek, and Danish governments, followed by the British government, then the French and German governments, and finally the U.S. Treasury, gave the temporary guarantees that they could and should have offered on September 15. That was the week the purely financial crisis effectively ended.


pages: 782 words: 187,875

Big Debt Crises by Ray Dalio

Asian financial crisis, asset-backed security, bank run, banking crisis, basic income, Ben Bernanke: helicopter money, break the buck, Bretton Woods, British Empire, business cycle, capital controls, central bank independence, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, declining real wages, European colonialism, fiat currency, financial innovation, German hyperinflation, housing crisis, implied volatility, intangible asset, Kickstarter, large denomination, manufacturing employment, margin call, market bubble, market fundamentalism, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Northern Rock, Ponzi scheme, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, refrigerator car, reserve currency, short selling, sovereign wealth fund, too big to fail, transaction costs, universal basic income, value at risk, yield curve

In an effort to weaken those countries, the French government encouraged the Bank of France and other French banks to withdraw the short-term credit they had provided to Austria.103 Viewing the interconnectedness of global financial institutions and the weakness of Europe as potential threats to its domestic recovery, the United States began to study methods of relieving the pressure on the German economy. On May 11, President Hoover asked Treasury Secretary Mellon and Secretary of State Henry Stimson to look into relaxing Germany’s significant payments for war debts and reparations. A proposal was not put forth until early the next month.104 In the interim, bank runs spread throughout Europe. Hungary reported bank runs starting in May, leading to the imposition of a bank holiday.105 The German government nationalized Dresdner Bank, the nation’s second largest bank, by buying its preferred shares.106 Major financial institutions failed across Romania, Latvia, and Poland.107 Germany was facing capital flight. The country’s gold and foreign exchange reserves fell by a third in June, to the lowest level in five years.

This foreshadowed FDR’s win in the presidential election two years later.90 First Quarter, 1931: Optimism Gives Way to Gloom as Economy Continues to Deteriorate At the start of 1931, economists, politicians, and other experts in both the US and Europe still retained hope that there would be an imminent return to normalcy because the problems still seemed manageable. The bank failures of the previous quarter were thought to be inconsequential, and not damaging to the overall financial system. By March, all business indexes were pointing to a rise in employment, wages, and industrial production. Bank runs led to a less than 10 percent drop in deposits.91 The news reflected growing economic confidence: on March 23, the New York Times declared that the depression had bottomed, and the U.S. economy was on its way back up.92 New investment trusts were being formed to profit from the expected “long recovery.”93 Optimism was also bolstered by the recovery of the stock market. Through the end of February, the Dow rose more than 20 percent off its December lows.

Classically, in a balance of payments crisis, interest rate increases large enough to adequately compensate holders of debt in weak currency for the currency risk are way too large to be tolerated by the domestic economy, so they don’t work. This was no exception, so a week later, the New York Fed again raised its interest rate to 3.5 percent.129 Rumors flew that the head of the New York Fed, George Harrison, had asked the French not to withdraw any more gold from the United States.130 Given the domestic difficulties, investors in the US had taken to hoarding gold and cash. This led to a series of bank runs in late 1931 that caused many banks to close and resulted in a big contraction in deposits for those remaining open. As banks’ deposits fell, they began to call their loans in order to build up their cash reserves. Homes and farms were forced into foreclosure, and several companies went bankrupt as investors did not roll loans they had previously extended.131 As money and credit contracted, the economy started to fall off a cliff.


pages: 479 words: 113,510

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America by Danielle Dimartino Booth

Affordable Care Act / Obamacare, asset-backed security, bank run, barriers to entry, Basel III, Bernie Sanders, break the buck, Bretton Woods, business cycle, central bank independence, collateralized debt obligation, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, greed is good, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, liquidity trap, London Whale, Long Term Capital Management, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, negative equity, new economy, Northern Rock, obamacare, price stability, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

Starting in 1996, Gorton worked as a consultant at AIG Financial Products (AIGFP), a tiny London-based division of the insurance giant. (Remember that name.) He advised the company on structured credit, credit derivatives, and commodity futures. So he had theory and practice to give him insight. Gorton pointed out that the collapse of numerous hedge funds in the summer of 2007 had been triggered by “wholesale” panics, not “retail” panics like the bank runs of the 1880s, 1907, and the 1930s. Those bank runs ended when the Federal Deposit Insurance Corporation was created in 1934, insuring bank accounts up to one hundred thousand dollars. During the American banking world’s so-called Quiet Period—from 1934 to 2007—some banks failed and thrifts went under, but those did not contaminate the broader banking system. However, the financial system had undergone deep and treacherous structural changes, negating the fundamental assumptions held by economists about the way the economy worked.

And my laptop was right beside me, at risk of being crushed when toddlers William and Henry came barreling across the bed in fits of happy giggles. So much was taking place in world financial markets while I sat tight, safeguarding the growth of my double cargo until my December due date. The rolling disaster rippled around the world. Insomnia kept me up late. Instead of I Love Lucy reruns, I watched the BBC as thousands of Brits queued to withdraw one billion pounds from Northern Rock, the biggest UK bank run in over a century. Markets sniff out the weakest links in the system. The cost of protecting the debt of big U.S. investment banks became the train wreck I couldn’t stop watching. I began following bank credit default swaps. These insurance securities could be used to bet for or against the survival of any financial entity—for example, the sovereign debt of Iceland or the corporate bonds of General Motors.

After I became friendly with people on the bond desk at Bear, I’d quietly call one of my buddies and ask, “How bad is my own desk ripping my head off?” They’d get me realistic pricing. I’d take that back to my traders to finagle a better deal for my client. The DLJ bond desk didn’t need to pad its sizable commission at my clients’ expense. That brand of greed was one of my pet peeves about Wall Street. Dudley would later call the Bear Stearns debacle in March 2008 an old-fashioned bank run, just like that depicted in the 1946 movie It’s a Wonderful Life, played out in real time on CNBC. But it had really started in 2007, during the ten-day crisis as its hedge funds crumbled. Cayne, age seventy-three, had come under attack for being AWOL, playing a bridge tournament in Nashville instead of tending to agitated investors. Cayne exhibited a bizarre indifference during this tumultuous period.


pages: 348 words: 99,383

The Financial Crisis and the Free Market Cure: Why Pure Capitalism Is the World Economy's Only Hope by John A. Allison

Affordable Care Act / Obamacare, American ideology, bank run, banking crisis, Bernie Madoff, business cycle, clean water, collateralized debt obligation, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, fiat currency, financial innovation, Fractional reserve banking, full employment, high net worth, housing crisis, invisible hand, life extension, low skilled workers, market bubble, market clearing, minimum wage unemployment, money market fund, moral hazard, negative equity, obamacare, Paul Samuelson, price mechanism, price stability, profit maximization, quantitative easing, race to the bottom, reserve currency, risk/return, Robert Shiller, Robert Shiller, The Bell Curve by Richard Herrnstein and Charles Murray, too big to fail, transaction costs, yield curve, zero-sum game

In Chapter 18, on solutions to the financial crisis, I will share with you some ideas for dealing with this issue without losing the benefits of magnifying the economic efficiency of intermediate-size investments and small savings that banks provide. The Federal Reserve and FDIC insurance were both created to deal with the issues associated with the nature of fractional reserve banking. In the short term, these “solutions” help; in the long term, they make the problem far, far worse. FDIC insurance primarily reduces the short-term risk of bank runs because depositors perceive their deposits to be insured by the federal government. However, I previously described the fact that FDIC insurance substantially increases the credit and liquidity risk that banks take by eliminating market discipline. Based on my long-term observation of the behavior of bank executives (human nature), the existence of FDIC insurance changes the risk/return trade-offs so significantly that in the good times (when bad loans are made), bankers take risks that they would never take in a free market.

Uninsured depositors do get paid in full on the portion of their deposits that is insured (theoretically, $100,000 is insured, but often much more is insured, as discussed previously). Until the WaMu failure, the idea had been that uninsured depositors would impose discipline on a reckless bank, knowing in advance that they could lose money in the event of a bankruptcy. The reason the FDIC and the other regulators decided to pay uninsured depositors was to avoid creating a bank run. When IndyMac had failed, the FDIC had not paid uninsured depositors in full. This created lines of depositors waiting to get their money, which were broadcast endlessly by the media. The regulators were concerned that a similar display might cause the general public to panic and demand their money out of healthy banks (remember the fractional reserve issue we discussed before). While the regulators had a legitimate concern, the manner in which they chose to handle WaMu was even more destructive.

Even though it was sold to Wells Fargo (with the shareholders getting a small amount) and the FDIC did not suffer a loss, its sale was mandated by the FDIC and the Fed. If the government forces the sale of a company, that company has failed (fairly or not). The interesting aspect of this situation is that the negative consequences for the bond market could have been avoided and the risk of retail bank runs controlled. The FDIC could have simply absorbed the extra losses paid to the uninsured depositors. The FDIC’s mission is to protect the safety and soundness of the banking system. If covering uninsured depositors is necessary, it can do so, but it should let the losses fall on the insurance fund, not on innocent bondholders. Violating the rule of law has consequences. The bursting of the real estate–market bubble turned into an international financial crisis for several reasons.


pages: 218 words: 63,471

How We Got Here: A Slightly Irreverent History of Technology and Markets by Andy Kessler

Albert Einstein, Andy Kessler, animal electricity, automated trading system, bank run, Big bang: deregulation of the City of London, Bob Noyce, Bretton Woods, British Empire, buttonwood tree, Claude Shannon: information theory, Corn Laws, Douglas Engelbart, Edward Lloyd's coffeehouse, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, Grace Hopper, invention of the steam engine, invention of the telephone, invisible hand, Isaac Newton, Jacquard loom, James Hargreaves, James Watt: steam engine, John von Neumann, joint-stock company, joint-stock limited liability company, Joseph-Marie Jacquard, Kickstarter, Leonard Kleinrock, Marc Andreessen, Maui Hawaii, Menlo Park, Metcalfe's law, Metcalfe’s law, Mitch Kapor, packet switching, price mechanism, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, railway mania, RAND corporation, Robert Metcalfe, Silicon Valley, Small Order Execution System, South Sea Bubble, spice trade, spinning jenny, Steve Jobs, supply-chain management, supply-chain management software, trade route, transatlantic slave trade, tulip mania, Turing machine, Turing test, undersea cable, William Shockley: the traitorous eight

Interest rates went up, another byproduct of too much money and inflation, which often caused banks to fail, and resulted in runs on those banks. The fractional reserve banking system was anything but stable, all because too much gold was in the British banking system. England had become Spain, laden with gold and not enough to spend it on. So England devised a way to get rid of gold. It turned out, at least in my opinion, to be the wrong way. *** Bank runs and financial crises from too much gold became common: They occurred in 1825, 1847, 1857 and 1866. Think about it. In periods of inflation, money loses its value relative to the goods it is buying. This lack of faith in money causes people to move into real assets, including gold. Even though money was exchanged into gold at a fixed rate, the fear that the rate would change when the money lost value, caused depositors to ask for real gold from banks.

And, in general, we may observe, that the dearness of every thing, from plenty of money, is a disadvantage, which attends an established commerce, and sets bounds to it in every country, by enabling the poorer states to undersell the richer in all foreign markets.” The best and brightest economists of the time met in Paris in 1867, to discuss a way to have both sound money and increased international trade. They came up with a system known as the “Price specie flow.” Sounds like a case of the runs, rather than a cure for bank runs. In 1870, even though England’s economic power had already peaked (but who knew?), the bankers and government officials agreed to this system - better known as the classical gold standard - since the economists were promising them a system that would naturally balance trade and keep governments from screwing up by issuing too much or too little money. There were four “rules of the game.” 1. 2. 3. 4.

But no, the U.S. was back on the gold standard and not allowed to increase the money supply, lest gold leave the country. Herbert Hoover vacuumed up whatever capital was left by increasing the top tax rate from 25 to 60 percent. In response, Franklin Roosevelt campaigned with "I pledge you, I pledge myself, to a new deal for the American people." In March 1933, just after FDR’s inauguration, unemployment hit 25 percent. After yet another bank run Roosevelt declared an 8-day banking holiday after which confidence in banks returned and deposits flowed back in. Later in 1933, the U.S. dropped the gold standard, following England, which dropped it in 1931. Unshackled, money supply could now increase and replenish banks. After a yearlong recession in 1938, New Deal spending kick-started the economy. A world war kept it going. MODERN GOLD 167 *** Meanwhile, the Germans were stuck paying WW I reparations.


pages: 492 words: 118,882

The Blockchain Alternative: Rethinking Macroeconomic Policy and Economic Theory by Kariappa Bheemaiah

accounting loophole / creative accounting, Ada Lovelace, Airbnb, algorithmic trading, asset allocation, autonomous vehicles, balance sheet recession, bank run, banks create money, Basel III, basic income, Ben Bernanke: helicopter money, bitcoin, blockchain, Bretton Woods, business cycle, business process, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, cashless society, cellular automata, central bank independence, Claude Shannon: information theory, cloud computing, cognitive dissonance, collateralized debt obligation, commoditize, complexity theory, constrained optimization, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crowdsourcing, cryptocurrency, David Graeber, deskilling, Diane Coyle, discrete time, disruptive innovation, distributed ledger, diversification, double entry bookkeeping, Ethereum, ethereum blockchain, fiat currency, financial innovation, financial intermediation, Flash crash, floating exchange rates, Fractional reserve banking, full employment, George Akerlof, illegal immigration, income inequality, income per capita, inflation targeting, information asymmetry, interest rate derivative, inventory management, invisible hand, John Maynard Keynes: technological unemployment, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, knowledge economy, large denomination, liquidity trap, London Whale, low skilled workers, M-Pesa, Marc Andreessen, market bubble, market fundamentalism, Mexican peso crisis / tequila crisis, MITM: man-in-the-middle, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, natural language processing, Network effects, new economy, Nikolai Kondratiev, offshore financial centre, packet switching, Pareto efficiency, pattern recognition, peer-to-peer lending, Ponzi scheme, precariat, pre–internet, price mechanism, price stability, private sector deleveraging, profit maximization, QR code, quantitative easing, quantitative trading / quantitative finance, Ray Kurzweil, Real Time Gross Settlement, rent control, rent-seeking, Satoshi Nakamoto, Satyajit Das, savings glut, seigniorage, Silicon Valley, Skype, smart contracts, software as a service, software is eating the world, speech recognition, statistical model, Stephen Hawking, supply-chain management, technology bubble, The Chicago School, The Future of Employment, The Great Moderation, the market place, The Nature of the Firm, the payments system, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, trade liberalization, transaction costs, Turing machine, Turing test, universal basic income, Von Neumann architecture, Washington Consensus

Implementation (as ofJune 2016) Pension consultants now need to register with SEC Home Mortgage Disclosure Act Source: Dodd-Frank: Washington, “We Have a Problem,” Lopez and Saeidinezhad (2016), Milken Institute These shortcomings were discussed by Neel Kashkari, the new president of the Federal Reserve Bank of Minneapolis, in a recent speech (February 2016) at the Hutchings Center at the Brookings Institute. In the speech, Kashkari questioned the usefulness and effectiveness of the measures and tools currently at our disposal and enquired if they were sufficient to deal with a future crisis, especially since we have no idea about what form it could take. In this public discussion, he presented two scenarios: Scenario One: Individual large bank runs into trouble while the rest of the economy is sound and strong. Scenario Two: One or more banks run into trouble while there is broader weakness and risk in the global economy. In Scenario One, as per Kashkari, the aforementioned measures would allow us to deal with the failure of an individual large bank without requiring a bailout, but we don’t know that for certain as the work on these measures is far from complete (refer Table 2-1). For example: A review of the Living Wills show that they have significant shortcomings13 and do not insure that the failure of a particular bank will not lead to massive fallout.

As such, they are responsible for ensuring how much debt is issued by commercial banks, without which they would not be able to control the supply of money. This lever of control exists in the form of capital requirements. 7 Chapter 1 ■ Debt-based Economy: The Intricate Dance of Money and Debt Capital requirements play an important role in the production of debt-based money as they offer, among other things, a safeguard to a bank run. Since a bank creates money as it makes out loans, they are at risk of running out of physical currency in the case that a large number of the depositors decide to withdraw their deposits. To address this risk, commercial banks are obliged to hold some amount of currency to meet deposit withdrawals and other outflows, but using physical banknotes to carry out these large volume transactions would be extremely cumbersome.

While all the services they provide can be grouped under the umbrellas of financing and risk mitigation, the fact that regulations can vary from geography to geography (and the lack of interoperability) means that there is always a dependence on intermediaries and repetition of processes. As stated by Lamar Wilson, CEO of Fluent, a Blockchain network for financial institutions and global enterprises, “Currently, bank-run trade finance programs require a tremendous amount of resource-intensive due diligence, document collection, and processing, including coordination of remittance information. Financing rates are high for the businesses despite the low and shrinking margins for the financing provider. This is especially true at smaller banks who lack this infrastructure and must outsource these services for their larger clients," (Harris, 2016).


pages: 593 words: 189,857

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

Affordable Care Act / Obamacare, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bernie Madoff, Bernie Sanders, break the buck, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, David Brooks, Doomsday Book, eurozone crisis, financial innovation, Flash crash, Goldman Sachs: Vampire Squid, housing crisis, Hyman Minsky, illegal immigration, implied volatility, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, Nate Silver, negative equity, Northern Rock, obamacare, paradox of thrift, pets.com, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, RAND corporation, regulatory arbitrage, reserve currency, Saturday Night Live, savings glut, selection bias, short selling, sovereign wealth fund, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

But when people lost confidence in a bank—sometimes because of rational concerns about its lending or leadership, sometimes not—they would all want their money back at the same time. The result was a run on the bank, like the famous scene in It’s a Wonderful Life when depositors rush to pull their money out of a Depression-era savings and loan. Confidence is a fragile thing. When it evaporates, it usually evaporates quickly. And it’s hard to get back once it’s lost. A financial crisis is a bank run writ large, a run on an entire financial system. People lose confidence that their money is safe—whether they’re stockholders or bondholders, institutional investors or elderly widows—so they rush to pull it out of the system, which makes the money remaining in the system even less safe, which makes everyone even less confident. This has happened a lot throughout history, in rich countries and poor ones, in sophisticated systems and simple ones.

The government can stand behind faltering firms, removing the incentives that turn fear into panic. Banks under siege used to stack money in their windows to reassure depositors there was no need to run; when governments put enough “money in the window,” they can reduce the danger they’ll have to use it. The classic example is deposit insurance, Franklin Delano Roosevelt’s response to Depression-era bank runs. Since 1934, the government has guaranteed deposits at banks, so insured depositors who get worried that their bank has problems no longer have an incentive to yank out their money and make the problems worse. Of course, the banking system that FDR inherited didn’t have “collateralized debt obligations,” “asset-backed commercial paper,” or other complexities of twenty-first-century finance. In the panic of 2008, insured bank deposits didn’t run on any significant scale, but all kinds of other frightened money did—and in the digital age, a run doesn’t require any physical running, just a phone call or a click of a mouse.

This is especially dangerous when their borrowing is in the form of short-term debt that can run when the mania ends. The classic example is a bank that borrows short from its depositors, who can demand their money back at any time, and lends long to businesses and homeowners. This kind of “maturity mismatch”—the use of short-term funding to finance long-term investments—is how George Bailey got into trouble in It’s a Wonderful Life, and it’s why we now have deposit insurance to avoid bank runs. But a lot of short-term loans to financial institutions can look a lot like uninsured bank deposits, and they can run when confidence goes. When creditors call in the loans and the institutions can’t recover the money they had lent to finance longer-term investments, they can fail in a hurry. This is unfortunate if it happens to a single bank, but devastating if it happens to the banking system as a whole.


pages: 471 words: 97,152

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

"Robert Solow", affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, business cycle, buy and hold, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, George Akerlof, George Santayana, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Paul Samuelson, plutocrats, Plutocrats, price stability, profit maximization, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, working-age population, Y2K, Yom Kippur War

The wizard himself was the great deceiver, the U.S. president.14 These and other images stay with us as symbolic testimony to the importance of some of the elements of our theory of animal spirits. The Overheated Economy of the 1920s Leads to the Depression of the 1930s After the depression of the 1890s there was much discussion of what had happened, and eventually corrections were made that were supposed to prevent a recurrence. Notably the Federal Reserve System was created by an act of Congress in 1913 to prevent the kind of bank run that had started the depression. The act was hailed as a “fireproof credit structure”15 and a “safeguard against business depressions.” President Woodrow Wilson, upon signing the Federal Reserve Act on December 14, 1913, was almost euphoric about its ability to stabilize the economy, and he even called the act “the constitution of peace.”16 But in fact the new system did not function as well as had been hoped.

Confidence—and the economy itself—was not restored until World War II completely changed the dominant story of people’s lives, transforming the economy.39 Summing Up Depression History We have seen that the two most significant depressions in U.S. history were characterized by fundamental changes in confidence in the economy, in the willingness to press pursuit of profit to antisocial limits, in money illusion, and in changes in the perception of economic fairness. The depressions were intimately linked with these hard-to-measure variables. These two epochs may seem remote in history, and we may think that our economic institutions have improved enough to prevent such events from ever being repeated. Both depressions involved bank runs, and such runs now appear to be a thing of a past because of the establishment, in the 1930s, of comprehensive deposit insurance. The first of these depressions also preceded the founding of the U.S. central bank, the Federal Reserve System; and there has been considerable development in the theory of central banking since the second depression. On the other hand, the subprime crisis may be directly traced to a shortcoming of modern deposit insurance.

On the other hand, the subprime crisis may be directly traced to a shortcoming of modern deposit insurance. A shadow banking sector, unprotected by deposit insurance, grew up after the early 1990s in the United States, in the form of subprime lenders who supported their lending activities by issuing short-term commercial paper. Moreover, even the Federal Reserve System as it existed at the beginning of 2007 was apparently not up to the task of preventing behavior that looked very much like bank runs, as one financial institution after another failed. In response the Fed had to reinvent itself, with new lending facilities that went far beyond its original turf of depository institutions. The increasing complexity of our financial system makes it hard for economic institutions like deposit insurers or central banks to stay ahead of financial innovation. Central banks today are concerned about deflation, and they are unlikely to let it happen.


pages: 361 words: 97,787

The Curse of Cash by Kenneth S Rogoff

Andrei Shleifer, Asian financial crisis, bank run, Ben Bernanke: helicopter money, Berlin Wall, bitcoin, blockchain, Boris Johnson, Bretton Woods, business cycle, capital controls, Carmen Reinhart, cashless society, central bank independence, cryptocurrency, debt deflation, disruptive innovation, distributed ledger, Edward Snowden, Ethereum, ethereum blockchain, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial exclusion, financial intermediation, financial repression, forward guidance, frictionless, full employment, George Akerlof, German hyperinflation, illegal immigration, inflation targeting, informal economy, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, Johannes Kepler, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, moveable type in China, New Economic Geography, offshore financial centre, oil shock, open economy, payday loans, price stability, purchasing power parity, quantitative easing, RAND corporation, RFID, savings glut, secular stagnation, seigniorage, The Great Moderation, the payments system, The Rise and Fall of American Growth, transaction costs, unbanked and underbanked, unconventional monetary instruments, underbanked, unorthodox policies, Y2K, yield curve

In the extreme case, the government could adopt a version of the 1930s “Chicago plan,” which would essentially allow banks to issue money-like instruments only if they were 100% backed by government debt, which presumably can include central bank reserves.10 The name relates to Chicago economists Henry Simon, Frank Knight, Milton Friedman, and Irving Fisher (the last actually a Yale professor), who advocated the idea of “narrow banking” to mitigate moral hazard problems and eliminate bank runs (assuming that the government itself is fully solvent). A Chicago-type plan would mark a quantum change in the financial system and would radically reroute the way capital flows in the economy. By expanding the scope of the government’s monopoly on all retail transaction media, the government would be able to raise vast amounts of capital, essentially usurping one of the private banking system’s main funding mechanisms.

Another common practice, even more directly analogous to a Gesell tax, was to force people to hand in coins and then give them back a smaller number of coins similar in weight and content, for example, handing in four coins and getting back three.13 Many other ways can be used to implement a crude Gesell tax. At the improbable (but instructive) end of the spectrum is the idea of creating short-stick lotteries advanced by my Harvard colleague N. Gregory Mankiw, who attributes the idea to a graduate student. Mankiw proposed that the central bank run regular lotteries based on the serial numbers of currency in circulation. Notes with the losing numbers become completely worthless. The problem is that after a couple dozen lotteries, it would be pretty difficult to identify worthless notes without a tedious serial number cross-check against the official list. This inconvenience would, in turn, once again greatly diminish the liquidity of currency.

Regardless of author Frank Baum’s intentions, there is little doubt that deflation occurred at times under the gold standard, and the problem illustrates some of the drawbacks of any commodity-backed currency. Indeed, the idea that the gold standard produced spectacular stability is a fantasy and a false image of what the gold standard was really like. The gold standard era was punctuated by deep recessions (the recession of 1893 was in some ways almost as profound as the Great Depression of the 1930s). There were bank runs and long bouts of deflation. Nothing stopped governments from abandoning the gold standard when they desperately needed funding to pay for World War I. Once citizens realized that the gold standard might not go on forever, it proved extremely fragile. There is little reason to believe that a modern-day gold standard would fare any better. Efforts to design an alternative rule-based monetary system have proved elusive, although some progress has been made.


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

asset-backed security, bank run, banking crisis, Bernie Madoff, bonus culture, Bretton Woods, business cycle, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, disintermediation, diversification, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, George Santayana, global reserve currency, Home mortgage interest deduction, Isaac Newton, joint-stock company, Kickstarter, liquidity trap, London Interbank Offered Rate, long peace, margin call, market clearing, mass immigration, money market fund, moral hazard, mortgage tax deduction, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, plutocrats, Plutocrats, Ponzi scheme, profit maximization, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, The Great Moderation, the new new thing, the payments system, too big to fail, value at risk, very high income, War on Poverty, Y2K, yield curve

However, like any ‘‘privileged opportunity,’’ there are strings attached. One string is simply that banks need to make a profit. People prefer to put their money in a bank that isn’t losing money. In fact, banks that lose big sums of money, especially when it is unexpected, can be quickly brought down by a ‘‘run on the bank.’’ Depositors in these dramas rush to remove their money before the banks go bust, something that is sure to make it go bust. Bank runs brought down thousands of U.S. banks in the 1920s and 1930s, which is why the Federal Deposit Insurance Corporation (FDIC) was put in place to provide both oversight and deposit insurance to prevent them. But it’s not enough for banks to just avoid the rare disaster. Banks need to make enough money out of OPM to pay for the cost of running the payments system and other expenses. They also need to provide earnings growth and a dividend for the shareholders who give them capital.

In other words, the clearing house provided the first system of financial regulation. Voluntary self-regulation is not very popular these days. However, the simple fact is that no private clearing house has ever collapsed during a financial crisis. The history of formal regulation is less stellar. The United States has experienced two devastating structural financial crises and several lesser ones since the Federal Reserve was set up. The Northern Rock bank run in England (the first since 1866) happened after the U.K. abolished the old clearing house ‘‘club’’ and took up formal regulation. LONDON BECOMES MONEY MARKET TO THE WORLD The result of all these accidents of history was that England became the first national economy based on credit. Nothing really new in finance has been invented since. The building blocks have been simple to use once they actually existed.

If they can’t, banks could find themselves with a $1000 loan the borrower cannot possibly pay by selling stock. Borrowers walk away, leaving the bank with trash stocks. With their paper wealth wiped out, these same borrowers began defaulting on mortgages and other loans. Banks began to call in loans to raise cash, sending more customers into the tank. Soon, banks began to fail in large numbers, triggering more bank runs. Between the end of 1920 and FDR’s famous Bank Holiday of 1933, about 5,000 of America’s roughly 30,000 banks failed. Essentially, Ben Strong and the Federal Reserve Board let them fail, judging it irresponsible to bail out banks that made themselves insolvent. However, in banking, timing is everything. There is a very thin line between insolvency—being basically unable to pay your debts for lack of income or assets—and illiquidity—being unable to pay now because you can’t get the cash.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, margin call, Mark Zuckerberg, McMansion, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, Thales of Miletus, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

Creditors don’t have to lock their money up for years, borrowers can draw on their long-term future income, and banks can make money in the middle because the rate they pay to borrow money short is less than the rate they can charge to loan money long. Society benefits, too: long-term investments can be financed far more easily because they do not require creditors to sacrifice liquidity. The downside of maturity transformation is that a lot of creditors do sometimes want their money back at the same time. The most visible manifestation of this is the bank run, with people lining up outside branches to retrieve their cash. A bank run is the moment when the magic of maturity transformation is revealed as a cheap trick. The bank doesn’t have deposits on hand to meet demand, so the customers who turn up first are the ones who get their money back. Everyone has an interest in joining the run. The purpose of deposit insurance, which was introduced in the United States in the 1930s and is common to most but not all countries, is to prevent runs by reassuring people that they will never lose money below a certain threshold, even if the bank goes bust. *** BANKS SOLVE THE PROBLEM of liquidity by standing in between savers and borrowers, promising the former instant access to their money even as they loan it out for long periods to the latter.

The interbank markets, where banks loan money to each other, had suddenly seized up, as institutions realized that they could not be sure of the standing of their counterparties. Something unexpected was happening to the moneymaking machine. My very first week in the job coincided with a deposit run at Northern Rock, a British lender that came unstuck when it could no longer fund itself in the markets. Some of my earliest interviews on the beat were with people dusting off the manual on how to deal with bank runs. Organizing guide ropes inside bank branches was one tactic: better that than have people spill out onto the street, signaling to others that they should join the line. One HSBC veteran happily recounted stories of the financial crisis that gripped Asia in the late 1990s, when tellers were instructed to bring piles of cash into view to reassure people that banks were overflowing with money. Tales of improvisation from Asia were not supposed to be relevant to the West’s ultrasophisticated financial system.

The aim of these rules is twofold: first, to make sure that banks do not get into such terrible trouble again and, second, to ensure that when there is another crisis, the bill is not passed to the taxpayer. A lot of different weapons are being deployed in the service of these objectives, and despite the cries of those who say nothing has been done to hurt the banks, they are having a powerful effect. The two most important levers that regulators have to pull are liquidity and equity. Bank runs are not the only way that creditors can bring banks to their knees. Banks borrow short term in a lot of different markets and from a lot of different sources of capital. They borrow in repurchase, or “repo,” markets, pledging securities as collateral in return for cash; they borrow from money-market funds; they use commercial paper, a short-term capital-market instrument, to raise money; and so forth.


pages: 589 words: 128,484

America's Bank: The Epic Struggle to Create the Federal Reserve by Roger Lowenstein

bank run, Berlin Wall, Bretton Woods, business cycle, capital controls, central bank independence, Charles Lindbergh, corporate governance, fiat currency, financial independence, full employment, Long Term Capital Management, moral hazard, old-boy network, quantitative easing, The Wealth of Nations by Adam Smith, Upton Sinclair, walking around money

As Paul Warburg, one of the heroes of this story, was to observe with his trademark acuity, America’s banks resembled less an army commanded by a central staff than they did an inchoate legion of disjointed and disunited infantry. It was hardly surprising that throughout the latter half of the nineteenth century and into the early twentieth, the United States—alone among the industrial powers—suffered a continual spate of financial panics, bank runs, money shortages, and, indeed, full-blown depressions. This book tells the story of how, culminating in the days before Christmas 1913, the Federal Reserve came to be. It was not a gentle or an easy birth, nor was it swift. To Americans of the early twentieth century, especially farmers, the prospect of a central bank threatened the comfortable Jeffersonian principle of small government. To a people for whom local autonomy was sacrosanct, the notion of a powerful bank, joined to the even more powerful federal government, was deeply unnerving.

Taft publicly supported the commission and sent Aldrich a flattering note, expressing his eagerness to meet with “the levelest headed man in the country.” Three weeks later, the Democrats nominated William Jennings Bryan. A great orator though a twice-failed candidate, Bryan had no use for a commission run by Aldrich. At any rate, the Democrats backed a very different banking reform—deposit insurance. Oklahoma, a newly admitted state, had enacted deposit insurance the previous December, with the aim of discouraging bank runs. This solution dismayed orthodox bankers, who feared that insurance would serve as an invitation to reckless banking. If depositors had no reason to seek out well-managed banks, what would motivate bankers to discipline their lending? James Laughlin, author of the 1897 Indianapolis report, reacted as did many experts—with haughty disapproval. Deposit insurance, Laughlin said, was a vain attempt to “make men good by law.

Further stoking inflation fears, the Owen bill, as compared with the House measure, was more conducive to stimulating credit (credit is the basis of money; more of it leads to more dollars in circulation). For instance, at Warburg’s urging, the Senate cut reserve requirements below those in the House, enabling banks to issue more loans and, again, create more money. The most controversial feature in the Senate bill was a provision for a deposit guarantee. The notion of insuring deposits as a means of forestalling bank runs had been on the margins of the debate since 1907 and, of course, was favored by Bryan. It was considered a radical step—one that would encourage imprudent banking. Nonetheless, Wall Street, which had visions of a muscular Federal Reserve that would pump up credit and arm American banks to do business overseas, preferred the Senate’s version of Glass-Owen to the House’s. The upper chamber not only permitted national banks to open foreign branches but explicitly permitted the new Reserve Banks to trade in securities “at home or abroad.”


Manias, Panics and Crashes: A History of Financial Crises, Sixth Edition by Kindleberger, Charles P., Robert Z., Aliber

active measures, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Black Swan, Bonfire of the Vanities, break the buck, Bretton Woods, British Empire, business cycle, buy and hold, Carmen Reinhart, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, Corn Laws, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, death of newspapers, debt deflation, Deng Xiaoping, disintermediation, diversification, diversified portfolio, edge city, financial deregulation, financial innovation, Financial Instability Hypothesis, financial repression, fixed income, floating exchange rates, George Akerlof, German hyperinflation, Honoré de Balzac, Hyman Minsky, index fund, inflation targeting, information asymmetry, invisible hand, Isaac Newton, joint-stock company, large denomination, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, new economy, Nick Leeson, Northern Rock, offshore financial centre, Ponzi scheme, price stability, railway mania, Richard Thaler, riskless arbitrage, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, special drawing rights, telemarketer, The Chicago School, the market place, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, very high income, Washington Consensus, Y2K, Yogi Berra, Yom Kippur War

Moreover it encouraged banks to make riskier loans since they were confident that they were protected against runs by the owners of the larger deposits – if these riskier loans proved profitable, the owners of the banks would benefit and if the loans went into default, the owners would not have to worry about bank runs (although the market value of their own shares might decline and even become worthless). The implosion of the bubble in Japan in the 1990s caused the value of the loans of the banks headquartered in Tokyo and Osaka and various regional centers to decline sharply below the value of their liabilities. Nevertheless, there were no bank runs; the depositors were confident that they would be made whole by the government if any of the banks were closed. Deposit insurance has limited both bank runs and contagion in the runs from one troubled bank to other banks in a neighborhood. What accounts for the reluctance to provide insurance at an earlier date?

A guarantee fund of 20 million gulden was put together by the Austrian National Bank and the solid commercial banks; these imitations of earlier measures were of little assistance.37 Another moratorium was noted in Paris after the July Monarchy when the municipal council decreed that all bills payable in Paris between 25 July and 15 August should be extended by ten days. This moratorium sterilized the commercial paper in banking portfolios and did nothing to discourage a run by holders of notes.38 Clearing-house certificates The major device used in the United States to cope with bank runs prior to the establishment of the Federal Reserve System was the clearing-house certificate, which is a near-money substitute that was the liability of a group of large local banks. A bank subject to a run could pay the departing depositors with these certificates rather than with coin. The New York clearing-house was established in 1853 and the one in Philadelphia in 1858 after the panic of 1857.

Morgan, Chase Manhattan Bank, and the Union Bank of Switzerland to provide $3.6 billion of capital to prevent the collapse of LTCM; in exchange they acquired 90 percent of LTCM’s equity.58 These firms were large creditors of LTCM so the ‘bailout’ involved a change in the legal nature of their claim on LTCM. The Federal Reserve was concerned that if LTCM failed the markets would be paralyzed by the need to unwind its massive position in futures and options contracts and other types of derivatives. Deposit insurance Since 1934, federal deposit insurance in the United States has prevented bank runs by providing an ex ante guarantee of deposits. Initially the deposits were guaranteed up to $10,000 but gradually the ceiling on deposits was raised in stages and eventually reached $100,000 – and then $250,000 during the 2008 crisis. When large banks got into trouble, the FDIC deliberately removed all limits on the amounts of deposits covered by the guarantee to halt imminent runs and in practice it established that banks with significant deposits over $100,000 were ‘too big to fail’ (although the shareholders of these banks would probably lose all of their money).


pages: 350 words: 109,220

In FED We Trust: Ben Bernanke's War on the Great Panic by David Wessel

Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, Black Swan, break the buck, business cycle, central bank independence, credit crunch, Credit Default Swap, crony capitalism, debt deflation, Fall of the Berlin Wall, financial innovation, financial intermediation, fixed income, full employment, George Akerlof, housing crisis, inflation targeting, information asymmetry, London Interbank Offered Rate, Long Term Capital Management, market bubble, money market fund, moral hazard, mortgage debt, new economy, Northern Rock, price stability, quantitative easing, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, savings glut, Socratic dialogue, too big to fail

Trust companies weren’t full-fledged members of the consortiums of banks — called “clearinghouses” — that agreed to stand behind one another at times of stress to stabilize the financial system. Instead, trust companies had to rely on clearinghouse banks to process checks written by their customers. Knickerbocker Trust Company, the Bear Stearns of its day, had lent heavily to the copper speculators. When word of that circulated, scores of depositors descended on its offices to withdraw money, the sort of bank run that was frighteningly frequent before government deposit insurance arrived. Never mind that just two weeks before, the state banking examiner had found the institution had funds sufficient to pay its depositors. On October 18, the National Bank of Commerce said it would no longer act as the intermediary between Knickerbocker and the clearinghouse, a move as devastating to Knickerbocker as JPMorgan Chase’s decision to stop “clearing” — or processing payments — for Lehman Brothers in September 2008, contributing to that venerable firm’s bankruptcy.

The institution was still in its adolescence when it confronted and failed its biggest test: misstep after misstep on the Fed’s part turned a bad late-1920s recession into the Great Depression, an indictment made by Nobel laureate Milton Friedman and collaborator Anna Schwartz, and later expanded by Ben Bernanke in his years as an academic. In the preface to a collection of his essays on the Depression, Bernanke described those years as “an incredibly dramatic episode — an era of stock market crashes, bread lines, bank runs, and wild currency speculation, with the storm clouds of war gathering ominously in the background all the while. Fascinating, and often tragic, characters abound during this period, from hapless policy makers trying to make sense of events for which their experience had not prepared them to ordinary people coping heroically with the effects of the economic catastrophe.” The words might have applied accurately to the early twenty-first century.

Officials had also expected the strength of exports and the banking system, which they regularly pronounced “well capitalized,” to keep the economy moving forward. The early days of August had dampened that optimism as well. “In August, it crossed into the banking system. That’s when things got really complicated,” said Donald Kohn, the Fed’s vice chairman, who had long taken comfort from what Greenspan once dubbed — in another automotive metaphor — the “spare tire” theory of finance. The spare tire theory holds that when the banks run into trouble, companies and consumers can borrow directly or indirectly in credit markets where money market funds, insurance companies, pension funds, and others lend cash. Likewise, when credit markets are tight, companies and consumers can borrow from banks. Problems in one sector are offset by the other, in short, and the economy keeps right on rolling. This theory had held up pretty well over the past two decades.


pages: 263 words: 80,594

Stolen: How to Save the World From Financialisation by Grace Blakeley

"Robert Solow", activist fund / activist shareholder / activist investor, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, basic income, battle of ideas, Berlin Wall, Big bang: deregulation of the City of London, bitcoin, Bretton Woods, business cycle, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collective bargaining, corporate governance, corporate raider, credit crunch, Credit Default Swap, cryptocurrency, currency peg, David Graeber, debt deflation, decarbonisation, Donald Trump, eurozone crisis, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, fixed income, full employment, G4S, gender pay gap, gig economy, Gini coefficient, global reserve currency, global supply chain, housing crisis, Hyman Minsky, income inequality, inflation targeting, Intergovernmental Panel on Climate Change (IPCC), Kenneth Rogoff, Kickstarter, land value tax, light touch regulation, low skilled workers, market clearing, means of production, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, negative equity, neoliberal agenda, new economy, Northern Rock, offshore financial centre, paradox of thrift, payday loans, pensions crisis, Ponzi scheme, price mechanism, principal–agent problem, profit motive, quantitative easing, race to the bottom, regulatory arbitrage, reserve currency, Right to Buy, rising living standards, risk-adjusted returns, road to serfdom, savings glut, secular stagnation, shareholder value, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, the built environment, The Great Moderation, too big to fail, transfer pricing, universal basic income, Winter of Discontent, working-age population, yield curve, zero-sum game

It borrowed from other financial institutions over short-time horizons — often on an overnight basis — and lent long, issuing mortgages that wouldn’t mature for decades. When financial markets started to seize up in 2007, banks stopped lending to one another, and “the Rock” found itself unable to access international capital markets, meaning it couldn’t pay its debts. On 13 September 2007, the news broke that Northern Rock was seeking emergency support from the Bank of England: the first UK bank run since Overend. Both bank runs resulted from an asset bubble — one in railways, the other in housing. Both Northern Rock and Overend relied on borrowing from financial markets to finance their day-to-day liabilities. Both were eventually forced to appeal to the Bank of England for help. But there were also some critical differences between the two institutions. Overend lent money to companies that were building the UK’s railway networks: the same railway networks that we use to this day.

The repo markets that had developed before the crash, which allowed banks to borrow from one another using debt-based securities as collateral, seized up. Adam Tooze puts it succinctly: “Without valuation these assets could not be used as collateral. Without collateral there was no funding. And if there was no funding all the banks were in trouble, no matter how large their exposure to real estate”. Retail bank runs had been a thing of the past since the introduction of deposit insurance, but what happened in 2007 was essentially a giant bank run, led by other banks, which created a liquidity crisis – the banks didn’t have enough cash to meet their current liabilities. But the fire selling that resulted rapidly turned this liquidity crisis into a solvency crisis – the banks’ debts grew larger than their assets. The panic quickly spread across the pond to the City of London.


pages: 453 words: 117,893

What Would the Great Economists Do?: How Twelve Brilliant Minds Would Solve Today's Biggest Problems by Linda Yueh

"Robert Solow", 3D printing, additive manufacturing, Asian financial crisis, augmented reality, bank run, banking crisis, basic income, Ben Bernanke: helicopter money, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bitcoin, Branko Milanovic, Bretton Woods, BRICs, business cycle, Capital in the Twenty-First Century by Thomas Piketty, clean water, collective bargaining, computer age, Corn Laws, creative destruction, credit crunch, Credit Default Swap, cryptocurrency, currency peg, dark matter, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, Deng Xiaoping, Doha Development Round, Donald Trump, endogenous growth, everywhere but in the productivity statistics, Fall of the Berlin Wall, fear of failure, financial deregulation, financial innovation, Financial Instability Hypothesis, fixed income, forward guidance, full employment, Gini coefficient, global supply chain, Gunnar Myrdal, Hyman Minsky, income inequality, index card, indoor plumbing, industrial robot, information asymmetry, intangible asset, invisible hand, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, laissez-faire capitalism, land reform, lateral thinking, life extension, low-wage service sector, manufacturing employment, market bubble, means of production, mittelstand, Mont Pelerin Society, moral hazard, mortgage debt, negative equity, Nelson Mandela, non-tariff barriers, Northern Rock, Occupy movement, oil shale / tar sands, open economy, paradox of thrift, Paul Samuelson, price mechanism, price stability, Productivity paradox, purchasing power parity, quantitative easing, RAND corporation, rent control, rent-seeking, reserve currency, reshoring, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, school vouchers, secular stagnation, Shenzhen was a fishing village, Silicon Valley, Simon Kuznets, special economic zone, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, total factor productivity, trade liberalization, universal basic income, unorthodox policies, Washington Consensus, We are the 99%, women in the workforce, working-age population

Fisher identified all great depressions as starting from a point of overindebtedness: The public psychology of going into debt for gain passes through several more or less distinct phases: (a) the lure of big prospective dividends or gains in income in the remote future; (b) the hope of selling at a profit, and realizing a capital gain in the immediate future; (c) the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible.15 In the case of the Great Depression, the overindebtedness originated in reckless borrowing by corporations who had been encouraged by high-pressure salesmanship of investment bankers. The collapse of the debt bubble then led to a self-perpetuating vicious circle of falling asset prices, which, as Fisher knew from experience, made it hard to repay one’s debt. It led to further distressed selling, rising bankruptcies and even bank runs as loans went bad on banks’ balance sheets. He then described the process of debt-deflation, where attempts to liquidate assets in order to reduce debts become self-defeating, as the ensuing fall in prices raises the real value of debts even more. In other words, the real cost of borrowing is the nominal interest rate minus inflation, so deflation increases the cost of debt while inflation would reduce it.

In such an event, Fisher’s solution, as he recommended repeatedly in letters to President Roosevelt and colleagues, was basically reflation. He proposed that the central bank should simply increase the price level to near its 1926 level by expanding the money supply in line with his formulation of the Quantity Theory of Money. He also suggested stabilizing the financial system by providing a government guarantee of bank deposits to curb harmful and destructive bank runs. He believed that membership of the gold standard prevented the necessary monetary expansion since the dollars in circulation were constrained by the amount of gold. Dropping the gold standard would free the dollar and allow it to fall in value during a depression, which could boost exports and therefore the economy. He also proposed a gift or loan to employers who increase their labour force.

Injecting a great deal of cash into banks gave them some much-needed liquidity and prevented the stock market collapse from precipitating an immediate banking crisis. However, the Fed believed that further loosening of monetary policy might pump up the stock market bubble and lead to inflation. Between 1930 and 1933 the US money supply contracted by over a third, coinciding with a raft of bank failures. Between October 1930 and March 1933 there were four major bank runs. Most of these occurred between August 1931 and January 1932, when there were 1,860 bank failures and the money supply fell at an annual rate of 31 per cent. As deposits were withdrawn for fear of failure, banks had less money to lend, so the supply of credit to the economy evaporated, which led to downward pressure on output and prices. It was not just fear of encouraging a further run-up in prices of assets such as stocks that had made the Federal Reserve reluctant to pump money into the economy, where it was especially needed by a banking sector which was haemorrhaging deposits.


pages: 374 words: 113,126

The Great Economists: How Their Ideas Can Help Us Today by Linda Yueh

"Robert Solow", 3D printing, additive manufacturing, Asian financial crisis, augmented reality, bank run, banking crisis, basic income, Ben Bernanke: helicopter money, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bitcoin, Branko Milanovic, Bretton Woods, BRICs, business cycle, Capital in the Twenty-First Century by Thomas Piketty, clean water, collective bargaining, computer age, Corn Laws, creative destruction, credit crunch, Credit Default Swap, cryptocurrency, currency peg, dark matter, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, Deng Xiaoping, Doha Development Round, Donald Trump, endogenous growth, everywhere but in the productivity statistics, Fall of the Berlin Wall, fear of failure, financial deregulation, financial innovation, Financial Instability Hypothesis, fixed income, forward guidance, full employment, Gini coefficient, global supply chain, Gunnar Myrdal, Hyman Minsky, income inequality, index card, indoor plumbing, industrial robot, information asymmetry, intangible asset, invisible hand, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, laissez-faire capitalism, land reform, lateral thinking, life extension, manufacturing employment, market bubble, means of production, mittelstand, Mont Pelerin Society, moral hazard, mortgage debt, negative equity, Nelson Mandela, non-tariff barriers, Northern Rock, Occupy movement, oil shale / tar sands, open economy, paradox of thrift, Paul Samuelson, price mechanism, price stability, Productivity paradox, purchasing power parity, quantitative easing, RAND corporation, rent control, rent-seeking, reserve currency, reshoring, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, school vouchers, secular stagnation, Shenzhen was a fishing village, Silicon Valley, Simon Kuznets, special economic zone, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, total factor productivity, trade liberalization, universal basic income, unorthodox policies, Washington Consensus, We are the 99%, women in the workforce, working-age population

Fisher identified all great depressions as starting from a point of overindebtedness: The public psychology of going into debt for gain passes through several more or less distinct phases: (a) the lure of big prospective dividends or gains in income in the remote future; (b) the hope of selling at a profit, and realizing a capital gain in the immediate future; (c) the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; (d) the development of downright fraud, imposing on a public which had grown credulous and gullible.15 In the case of the Great Depression, the overindebtedness originated in reckless borrowing by corporations who had been encouraged by high-pressure salesmanship of investment bankers. The collapse of the debt bubble then led to a self-perpetuating vicious circle of falling asset prices, which, as Fisher knew from experience, made it hard to repay one’s debt. It led to further distressed selling, rising bankruptcies and even bank runs as loans went bad on banks’ balance sheets. He then described the process of debt-deflation, where attempts to liquidate assets in order to reduce debts become self-defeating, as the ensuing fall in prices raises the real value of debts even more. In other words, the real cost of borrowing is the nominal interest rate minus inflation, so deflation increases the cost of debt while inflation would reduce it.

In such an event, Fisher’s solution, as he recommended repeatedly in letters to President Roosevelt and colleagues, was basically reflation. He proposed that the central bank should simply increase the price level to near its 1926 level by expanding the money supply in line with his formulation of the Quantity Theory of Money. He also suggested stabilizing the financial system by providing a government guarantee of bank deposits to curb harmful and destructive bank runs. He believed that membership of the gold standard prevented the necessary monetary expansion since the dollars in circulation were constrained by the amount of gold. Dropping the gold standard would free the dollar and allow it to fall in value during a depression, which could boost exports and therefore the economy. He also proposed a gift or loan to employers who increase their labour force.

Injecting a great deal of cash into banks gave them some much-needed liquidity and prevented the stock market collapse from precipitating an immediate banking crisis. However, the Fed believed that further loosening of monetary policy might pump up the stock market bubble and lead to inflation. Between 1930 and 1933 the US money supply contracted by over a third, coinciding with a raft of bank failures. Between October 1930 and March 1933 there were four major bank runs. Most of these occurred between August 1931 and January 1932, when there were 1,860 bank failures and the money supply fell at an annual rate of 31 per cent. As deposits were withdrawn for fear of failure, banks had less money to lend, so the supply of credit to the economy evaporated, which led to downward pressure on output and prices. It was not just fear of encouraging a further run-up in prices of assets such as stocks that had made the Federal Reserve reluctant to pump money into the economy, where it was especially needed by a banking sector which was haemorrhaging deposits.


pages: 488 words: 144,145

Inflated: How Money and Debt Built the American Dream by R. Christopher Whalen

Albert Einstein, bank run, banking crisis, Black Swan, Bretton Woods, British Empire, business cycle, buy and hold, California gold rush, Carmen Reinhart, central bank independence, commoditize, conceptual framework, corporate governance, corporate raider, creative destruction, cuban missile crisis, currency peg, debt deflation, falling living standards, fiat currency, financial deregulation, financial innovation, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, global reserve currency, housing crisis, interchangeable parts, invention of radio, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mutually assured destruction, non-tariff barriers, oil shock, Paul Samuelson, payday loans, plutocrats, Plutocrats, price stability, pushing on a string, quantitative easing, rent-seeking, reserve currency, Ronald Reagan, special drawing rights, The Chicago School, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, Upton Sinclair, women in the workforce

Indeed, my recent book, Crisis Economics: A Crash Course in the Future of Finance (The Penguin Press HC, 2010) shows that financial crises and economic crises driven by irrational exuberance of the financial system and the private sector—unrelated to public policies—existed for centuries before fiscal deviant sovereign and central banks distorted private-sector incentives. Markets do fail, and they do fail regularly in irrationally exuberant market economies; that is the source of the role of central banks and governments in preventing self-fulfilling and destructive bank runs and collapses of economic activity via Keynesian fiscal stimulus in response to collapse in private demand. The fact that these monetary policies and fiscal policies may eventually become misguided—creating moral hazard and creating large fiscal deficits and debt—does not deny the fact that private market failures—independent of misguided policies—triggered asset and credit bubbles that triggered a public rescue response.

It is interesting to speculate how the financial markets in the United States and Europe would have reacted had a silverite such as Stevenson become president. Rothbard described the scene facing Cleveland in that terrible year: Poor Grover Cleveland, a hard money Democrat, assumed the presidency in the middle of this monetary crisis. Two months later, the stock market collapsed, and a month afterward, in June 1893, distrust of the fraction reserve banks led to massive bank runs and failures throughout the country. Once again, however, many banks, national and state, especially in the West and South, were allowed to suspend specie payments. The panic of 1893 was on.13 Despite long speeches by Bryan and other pro-silver members of the House, on August 28, 1893, the lower chamber voted 239–108 to repeal the Sherman Act. This was a tremendous victory for Cleveland, but not the end of the battle over silver in Congress.

“It was this interpretation of the episode that provided the prime impetus for the monetary reform movement that culminated in the Federal Reserve Act.”19 The Crisis of 1907 One of the key events that drove the mounting public demand for monetary reform was the Crisis of 1907, an event that was a century in the making but was also the result of a growing economy that had far outgrown its financial system. Unlike previous panics, the troubles started in March, not during the autumn farm harvest season, and would last the entire year and beyond. The New York Stock Exchange went into a drastic decline, leading to public panic and depositor runs on banks. These bank runs, in turn, led to large-scale liquidations of “call loans,” short-term loans used to finance stock market purchases, causing further declines in stock prices and widespread insolvency for businesses and individuals. Because the reaction to crisis by banks and the entire financial system was to limit the availability of deposits when a liquidity run occurred, the flow of payments through the U.S. economy slowed, causing personal and commercial insolvencies to soar.


pages: 632 words: 159,454

War and Gold: A Five-Hundred-Year History of Empires, Adventures, and Debt by Kwasi Kwarteng

accounting loophole / creative accounting, anti-communist, Asian financial crisis, asset-backed security, Atahualpa, balance sheet recession, bank run, banking crisis, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business cycle, California gold rush, capital controls, Carmen Reinhart, central bank independence, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, currency manipulation / currency intervention, Deng Xiaoping, discovery of the americas, Etonian, eurozone crisis, fiat currency, financial innovation, fixed income, floating exchange rates, Francisco Pizarro, full employment, German hyperinflation, hiring and firing, income inequality, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, liberal capitalism, market bubble, money: store of value / unit of account / medium of exchange, moral hazard, new economy, oil shock, plutocrats, Plutocrats, Ponzi scheme, price mechanism, quantitative easing, rolodex, Ronald Reagan, South Sea Bubble, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the market place, The Wealth of Nations by Adam Smith, too big to fail, War on Poverty, Yom Kippur War

The panic created more panic in a process Krugman said was similar to a microphone in an auditorium generating a ‘feedback loop’: ‘sounds picked up by the microphone are amplified by the loudspeakers’.22 These sounds are then amplified and increased until a deafening noise is created. The idea that a panic creates its own momentum is implicit in the phenomenon of a ‘bank run’, in which the prospect of a bank collapse actually causes this to happen, as depositors, doubtful of a bank’s solvency, remove their deposits, thereby damaging the bank. The feedback loop or bank run is essentially a circular process: it might be called a vicious circle. In the case of Thailand, the loss of investor confidence and the ensuing collapse in the value of the baht forced the central bank of Thailand to increase interest rates to defend the currency. Inevitably, both higher interest rates and a devalued currency created serious problems for Thai businesses and financial institutions.

Richards, the Deputy Governor of the Bank, remembered that ‘on Monday morning [12 December] the storm began, and till Saturday night it raged with an intensity that it is impossible for me to describe’.14 During that month, sixty county banks failed, more than half of them collapsing as a consequence of the failures of the London bank Pole & Co. and of Wentworth & Co., a leading Yorkshire bank. On 14 December, Pole & Co. stopped payment, which put forty of its correspondent county banks out of business.15 Pole & Co. had been put under pressure by an old-fashioned bank run, when depositors simply withdrew their money from the bank. The bank failures were only the last development of what had been a tumultuous year. The South American mining stocks also collapsed in dramatic fashion. One man caught up in the excitement of the stock market bubble was the young Benjamin Disraeli, a twenty-year-old Jewish adventurer, determined to make a name for himself in literature.

He believed that the future position of the City would be jeopardized if specie payments were suspended at the first sign of crisis.40 Already an informal adviser at the Treasury, he wished to retain gold payments for international transactions, but restrict them internally. The panic had seen banks, fearful for their own solvency, cashing in their banknotes for gold at the Bank of England and then, notoriously, refusing to supply their own customers with gold. This double standard aroused the ire of the young Cambridge economist. ‘Our system’, he wrote, ‘was endangered, not by the public running on the banks, but by the banks running on the Bank of England.’ As a result of this ‘internal run’, the central bank’s gold reserves had fallen from £17.5 million to £11 million in three days.41 The predicament of the banks, as described by Patrick Shaw Stewart, was acute. The ‘main difficulty in two words’, as this clever young banker saw it, was ‘to prop up those big houses who have debts owing from Germany which will never be paid, and, if they go under, to prevent the whole City coming down like a pack of cards’.42 The public, once the banks had suspended gold payments for customers, received paper money, notes issued by the British Treasury for everyday purposes, with denominations of £1 and 10 shillings (50p in modern terms).


pages: 248 words: 57,419

The New Depression: The Breakdown of the Paper Money Economy by Richard Duncan

asset-backed security, bank run, banking crisis, banks create money, Ben Bernanke: helicopter money, Bretton Woods, business cycle, currency manipulation / currency intervention, debt deflation, deindustrialization, diversification, diversified portfolio, fiat currency, financial innovation, Flash crash, Fractional reserve banking, income inequality, inflation targeting, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, market bubble, market fundamentalism, mass immigration, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, private sector deleveraging, quantitative easing, reserve currency, Ronald Reagan, savings glut, special drawing rights, The Great Moderation, too big to fail, trade liberalization

Contents Preface Chapter 1: How Credit Slipped Its Leash Opening Pandora’s Box Constraints on the Fed and on Paper Money Creation Fractional Reserve Banking Run Amok Fractional Reserve Banking Commercial Banks The Broader Credit Market: Too Many Lenders, Not Enough Reserves Credit without Reserves The Flow of Funds The Rest of the World Notes Chapter 2: The Global Money Glut The Financial Account How It Works What Percentage of Total Foreign Exchange Reserves Are Dollars? What to Do with So Many Dollars? What about the Remaining $2.8 Trillion? Debunking the Global Savings Glut Theory Will China Dump Its Dollars? Notes Chapter 3: Creditopia Who Borrowed the Money? Impact on the Economy Net Worth Profits Tax Revenue Different, Not Just More Impact on Capital Conclusion Note Chapter 4: The Quantity Theory of Credit The Quantity Theory of Money The Rise and Fall of Monetarism The Quantity Theory of Credit Credit and Inflation Conclusion Notes Chapter 5: The Policy Response: Perpetuating the Boom The Credit Cycle How Have They Done so Far?

EXHIBIT 1.3 Currency Outside Banks Source: Federal Reserve, Flow of Funds Although this new paper money was no longer backed by gold (or by anything at all), it still served as the foundation upon which new credit could be created by the banking system. Fifty trillion dollars worth of credit could not have been erected on the 1968 base of 44 billion gold-backed dollars. Fractional Reserve Banking Run Amok The other constraint on credit creation at the time the Federal Reserve was established was the requirement that banks hold reserves to ensure they would have sufficient liquidity to repay their customers’ deposits on demand. The Federal Reserve Act specified that banks must hold such reserves either in their own vaults or else as deposits at the Federal Reserve. The global economic crisis came about because, over time, regulators lowered the amount of reserves the financial system was required to hold until they were so small that they provided next to no constraint on the amount of credit the system could create.

In order to understand how reserve requirements limited credit creation, it is first necessary to understand how credit is created through Fractional Reserve Banking. Fractional Reserve Banking Most banks around the world accept deposits, set aside a part of those deposits as reserves, and lend out the rest. Banks hold reserves to ensure they have sufficient funds available to repay their customers’ deposits upon demand. To fail to do so could result in a bank run and possibly the failure of the bank. In some countries, banks are legally bound to hold such reserves, while in others they are not. A banking system in which banks do not maintain 100 percent reserves for their deposits is known as a system of fractional reserve banking. In such a system, by lending a multiple of the reserves they keep on hand, banks are said to create deposits. The following example illustrates how the process of deposit creation occurs.


pages: 597 words: 172,130

The Alchemists: Three Central Bankers and a World on Fire by Neil Irwin

"Robert Solow", Ayatollah Khomeini, bank run, banking crisis, Berlin Wall, Bernie Sanders, break the buck, Bretton Woods, business climate, business cycle, capital controls, central bank independence, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, currency peg, eurozone crisis, financial innovation, Flash crash, George Akerlof, German hyperinflation, Google Earth, hiring and firing, inflation targeting, Isaac Newton, Julian Assange, low cost airline, market bubble, market design, money market fund, moral hazard, mortgage debt, new economy, Northern Rock, Paul Samuelson, price stability, quantitative easing, rent control, reserve currency, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, savings glut, Socratic dialogue, sovereign wealth fund, The Great Moderation, too big to fail, union organizing, WikiLeaks, yield curve, Yom Kippur War

The country was just too big, with too many diverse economic conditions, to warrant putting a group of appointees in Washington in charge of the whole thing, Glass argued. President Woodrow Wilson, by contrast, wanted clearer political control and more centralization—he figured the institution would have democratic legitimacy only if political appointees in Washington were put in charge. The Senate, meanwhile, dabbled with approaches that would put the Federal Reserve even more directly under the thumb of political authorities, with the regional banks run by political appointees as well. But for all the apparent disagreement in 1913, there were some basic things that most lawmakers seemed to be in harmony about: There needed to be a central bank to backstop the banking system. It would consist of decentralized regional banks. And its governance would be shared—among politicians, bankers, and agricultural and commercial interests. The task was to hammer out the details.

In 1931, the unemployment rate climbed to 16 percent. In 1933, it reached 25 percent. The banking crisis spread to Europe when Credit-Anstalt, one of Vienna’s largest and most important banks, failed spectacularly in May 1931, as years of lending for questionable projects caught up with it. The Austrian government guaranteed the bank’s deposits—and suddenly found its own creditworthiness in question. The global bank run was on. If Credit-Anstalt could collapse, what about similarly overextended banks in Amsterdam and Warsaw? Or in Frankfurt and Munich? When large-scale withdrawals began at the major German banks, the Reichsbank was in an impossible position. A collapse of the German banking system would be a catastrophe for the economy. Yet for the central bank to backstop the system would mean expanding the money supply at a time when its gold reserves were already dwindling.

For the past several weeks, Northern Rock PLC, a bank based in the North East of England with £100 billion in assets, had been in crisis. Its business was to issue mortgages, which would then be packaged and sold on financial markets—and since August, mortgage securities had been toxic to global investors. Northern Rock faced a cash crunch, as depositors discovered just how bad its situation was, a classic bank run. Television news programs showed ominously long lines of Northern Rock customers waiting to pull their deposits. “You don’t want to be the ones in the end of the queue that the money’s run out,” an uncertain customer said to the cameras outside a branch in Reading. In a palatial Moorish hall, the governor of the Bank of England and the chancellor of the exchequer watched from afar—on TV, just like many of those Northern Rock customers determined not to be in the end of the queue when the money ran out.


pages: 417 words: 97,577

The Myth of Capitalism: Monopolies and the Death of Competition by Jonathan Tepper

Affordable Care Act / Obamacare, air freight, Airbnb, airline deregulation, bank run, barriers to entry, Berlin Wall, Bernie Sanders, big-box store, Bob Noyce, business cycle, Capital in the Twenty-First Century by Thomas Piketty, citizen journalism, Clayton Christensen, collapse of Lehman Brothers, collective bargaining, computer age, corporate raider, creative destruction, Credit Default Swap, crony capitalism, diversification, don't be evil, Donald Trump, Double Irish / Dutch Sandwich, Edward Snowden, Elon Musk, en.wikipedia.org, eurozone crisis, Fall of the Berlin Wall, family office, financial innovation, full employment, German hyperinflation, gig economy, Gini coefficient, Goldman Sachs: Vampire Squid, Google bus, Google Chrome, Gordon Gekko, income inequality, index fund, Innovator's Dilemma, intangible asset, invisible hand, Jeff Bezos, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, late capitalism, London Interbank Offered Rate, low skilled workers, Mark Zuckerberg, Martin Wolf, means of production, merger arbitrage, Metcalfe's law, multi-sided market, mutually assured destruction, Nash equilibrium, Network effects, new economy, Northern Rock, offshore financial centre, passive investing, patent troll, Peter Thiel, plutocrats, Plutocrats, prediction markets, prisoner's dilemma, race to the bottom, rent-seeking, road to serfdom, Robert Bork, Ronald Reagan, Sam Peltzman, secular stagnation, shareholder value, Silicon Valley, Skype, Snapchat, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, undersea cable, Vanguard fund, very high income, wikimedia commons, William Shockley: the traitorous eight, zero-sum game

Your consumption is my income, and your borrowing is my lending. In the summer of 2007, long lines of depositors started forming outside the bank Northern Rock in London. It was the first bank run in Britain since 1866. Ironically, the panic started when the Bank of England said Northern Rock was in fine shape and that it would stand by the bank. Problems can only be believed when they are officially denied. Immediately customers were alerted to problems and demanded the return of their deposits.34 Every depositor was behaving in a perfectly rational way, yet when all of them showed up to get their cash at the same time, they were causing the very bankruptcy they sought to avoid. (A bank run happens when customers try to withdraw more money from the bank than the bank can provide. Banks do not keep all customer deposits available in cash for immediate withdrawal, and instead the money is lent out.)

Banks do not keep all customer deposits available in cash for immediate withdrawal, and instead the money is lent out.) Mervyn King, governor of the Bank of England, once noted that it may not be rational to start a bank run, but it is rational to participate in one once it has started. It is illogical for you not to pull your money out of a bank when you're worried about the bank's solvency, but it is also illogical for everyone to pull their money at the same time, as that itself brings the bank down. The idea of the fallacy of composition applies in the field of energy as well. Coal was the main energy source in Victorian England. Charles Dickens had described the skies of industrial towns as “black vomit, blasting all things living or inanimate, shutting out the face of day, and closing in on all these horrors with a dense dark cloud.”35 In 1865, the English economist William Stanley Jevons published The Coal Question.

He inspired confidence and fear; he would stare with his piercing eyes, and one man said that a meeting with Morgan made him feel “as if a gale had blown through the house.” When Morgan died, the New York Stock Exchange closed until noon in his honor; it had previously only been closed to honor the passing of kings and presidents.1 He was the “boss of bosses” during the Gilded Age, and he singlehandedly saved the nation from economic collapse during the Panic of 1907. The Panic arose when the New York Stock Exchange fell 50% and bank runs ensued across the country. Morgan devised a plan to shore up the banking system with his personal money, and cash from wealthy friends and institutions. He provided liquidity to the country when America's own treasury failed. This outraged the nation – how could one man have gained such immense power and control? Morgan was famous for financing failing companies, gaining majority shareholdings, and then swooping in with his own managers and directors to aggressively focus on profitability.


pages: 100 words: 31,338

After Europe by Ivan Krastev

affirmative action, bank run, Berlin Wall, central bank independence, clean water, conceptual framework, creative destruction, deindustrialization, Donald Trump, eurozone crisis, failed state, Fall of the Berlin Wall, Francis Fukuyama: the end of history, illegal immigration, job automation, mass immigration, moral panic, open borders, post-work, postnationalism / post nation state, Silicon Valley, Slavoj Žižek, too big to fail, Wolfgang Streeck, World Values Survey, Y Combinator

What is necessary is that five years from now Europeans are capable of traveling freely in Europe, the euro is on track to survive as the common currency of at least some of the member states, and citizens are able both to elect their governments freely and to sue them in Strasbourg’s European Court of Human Rights. “Who speaks of victory?” asks the great German poet Rainer Maria Rilke. “To endure is all.” But even enduring will not be easy. If the union collapses, the logic of its fragmentation will be that of a bank run and not of a revolution. The EU’s implosion does not have to result from a victory of “exiters” over “remainers” in state referenda; it will more likely be an unintended consequence of the union’s long-term dysfunction (or perceived dysfunction), compounded by a misreading by elites of national political dynamics. In their fear that the union will fall apart and in a desire to hedge against such an outcome, many European leaders and governments will take actions that make the collapse of the European project a foregone conclusion.

What follows is not an argument about the advantages and disadvantages of direct democracy. What I argue, instead, is that in a political construction like the EU, where you have a lot of common policies, you have far fewer common politics. Where nobody can prevent member states voting on issues that can dramatically affect other states in the union, an explosion of national referendums is the fastest way to make the union ungovernable. Such an explosion could even trigger a “bank run” that could catalyze the breakup of the union. Europe can’t exist as a union of referendums because the EU is a space for negotiation while referendums are the final word of the people that preclude further negotiations. Referendums are therefore political instruments that can be easily misused by both Euroskeptical minorities and euro-pessimistic governments to block the work of the union. If the EU commits suicide, the weapon used will quite likely be a popular referendum or a series of popular referendums.


pages: 497 words: 150,205

European Spring: Why Our Economies and Politics Are in a Mess - and How to Put Them Right by Philippe Legrain

3D printing, Airbnb, Asian financial crisis, bank run, banking crisis, barriers to entry, Basel III, battle of ideas, Berlin Wall, Big bang: deregulation of the City of London, Boris Johnson, Bretton Woods, BRICs, British Empire, business cycle, business process, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, cleantech, collaborative consumption, collapse of Lehman Brothers, collective bargaining, corporate governance, creative destruction, credit crunch, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, currency peg, debt deflation, Diane Coyle, disruptive innovation, Downton Abbey, Edward Glaeser, Elon Musk, en.wikipedia.org, energy transition, eurozone crisis, fear of failure, financial deregulation, first-past-the-post, forward guidance, full employment, Gini coefficient, global supply chain, Growth in a Time of Debt, hiring and firing, hydraulic fracturing, Hyman Minsky, Hyperloop, immigration reform, income inequality, interest rate derivative, Intergovernmental Panel on Climate Change (IPCC), Irish property bubble, James Dyson, Jane Jacobs, job satisfaction, Joseph Schumpeter, Kenneth Rogoff, Kickstarter, labour market flexibility, labour mobility, liquidity trap, margin call, Martin Wolf, mittelstand, moral hazard, mortgage debt, mortgage tax deduction, North Sea oil, Northern Rock, offshore financial centre, oil shale / tar sands, oil shock, open economy, peer-to-peer rental, price stability, private sector deleveraging, pushing on a string, quantitative easing, Richard Florida, rising living standards, risk-adjusted returns, Robert Gordon, savings glut, school vouchers, self-driving car, sharing economy, Silicon Valley, Silicon Valley startup, Skype, smart grid, smart meter, software patent, sovereign wealth fund, Steve Jobs, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, Tyler Cowen: Great Stagnation, working-age population, Zipcar

But a bond-market panic is particularly pernicious because it can force even a solvent government to default, because it may not be able to raise funds quickly enough to meet its obligations. In that respect, a bond-market panic is like a bank run, where a dash for cash by depositors (or a refusal of other lenders to refinance its debts) can force even a solvent bank that can’t raise funds fast enough to fail. Bank runs used to be common and crippling until the central bank began stepping in as a “lender of last resort”, providing solvent banks with liquidity (cash loans secured against their assets). This not only ensured that solvent banks wouldn’t be felled by a liquidity crisis; it also stopped most bank runs from happening altogether, since depositors knew that the central bank stood ready to lend if necessary. For the same reasons, the central bank also typically acts as a lender of last resort to the government.

The various interlocking strands of the crisis came to a head in June 2012. After inconclusive elections in May, Greece was due to hold a re-run on 17 June. Syriza, a far-left party that wanted to renegotiate the country’s EU-IMF programme while remaining in the euro, looked set to win, with eurozone policymakers threatening to force Greece out if it did. That prospect was accelerating the slow-motion bank run across southern Europe, threatening a full-on stampede. Such was the fragmentation of eurozone financial markets that a creditworthy hotel in South Tirol (Italy) had to pay three percentage points more for a bank loan than its equivalent in North Tirol (Austria) – if it could borrow at all. In effect, the single market had shattered. As well as a liquidity crisis, many banks faced a solvency crisis.

Muddling through will not solve these problems: the longer zombie banks and excessive debts are allowed to fester, the longer economies will be sickly. Some believe the panacea is for southern European countries to reintroduce their own currencies. These would promptly depreciate, forcing them to default: a 25-per-cent depreciation would swell their euro-denominated debt burden by a third in their new currency; redenominating it would constitute a default too. Reintroducing a currency in the midst of a crisis would also provoke chaos: bank runs, lost savings, mass bankruptcies. But in any case, is devaluation really the solution? It hasn’t worked for Britain. Another solution, suggested by George Soros as a fallback option, is for Germany (or all the creditor countries) to leave the euro.316 The beauty of his proposal is that since southern Europe would keep the euro, it would not be forced to default, but that as the euro depreciated against the new Deutsche Mark, its debt burden in D-Mark terms would fall, imposing losses on Germany.


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Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions by Joshua Rosenbaum, Joshua Pearl, Joseph R. Perella

asset allocation, asset-backed security, bank run, barriers to entry, business cycle, capital asset pricing model, collateralized debt obligation, corporate governance, credit crunch, discounted cash flows, diversification, fixed income, intangible asset, London Interbank Offered Rate, performance metric, shareholder value, sovereign wealth fund, stocks for the long run, technology bubble, time value of money, transaction costs, yield curve

Prepare Stapled Financing Package The investment bank running the auction process (or sometimes a “partner” bank) may prepare a “pre-packaged” financing structure in support of the target being sold. The staple, which is targeted toward sponsors, was a mainstay in auction processes during the LBO boom of the mid-2000s. Although prospective buyers are not required to use the staple, historically it has positioned the sell-side advisor to play a role in the deal’s financing. Often, however, buyers seek their own financing sources to match or “beat” the staple. Alternatively, certain buyers may choose to use less leverage than provided by the staple. EXHIBIT 6.7 General Data Room Index To avoid a potential conflict of interest, the investment bank running the M&A sell-side sets up a separate financing team distinct from the sell-side advisory team to run the staple process.

., from Bloomberg), or both historical and predicted betas, and then show a range of outputs. 109 For simplicity, we assumed that the market value of debt was equal to the book value. 110 Ibbotson estimates a size premium of 1.65% for companies in the Low-Cap Decile for market capitalization. 111 Depending on the long-term structural effects of the subprime mortgage crisis and ensuing credit crunch, including the ability to raise debt at historical levels, these long-established benchmarks may be revisited. 112 The “free cash flow” term (“levered free cash flow” or “cash available for debt repayment”) used in LBO analysis differs from the “unlevered free cash flow” term used in DCF analysis as it includes the effects of leverage. 113 The term “investment bank” is used broadly to refer to financial intermediaries that perform corporate finance and M&A advisory services, as well as capital markets underwriting activities. 114 These letters are typically highly negotiated among the sponsor, the banks providing the financing, and their respective legal counsels before they are executed. 115 To compensate the GP for management of the fund, LPs typically pay 1% to 2% per annum on committed funds as a management fee. In addition, once the LPs have received the return of every dollar of committed capital plus the required investment return threshold, the sponsor typically receives a 20% “carry” on every dollar of investment profit. 116 LPs generally hold the capital they invest in a given fund until it is called by the GP in connection with a specific investment. 117 The investment bank running an auction process (or sometimes a “partner” bank) may offer a pre-packaged financing structure, typically for prospective financial buyers, in support of the target being sold. This is commonly referred to as stapled financing (“staple”). See Chapter 6: M&A Sale Process for additional information. 118 Alternatively, the banks may be asked to commit to a financing structure already developed by the sponsor. 119 The financing commitment includes: a commitment letter for the bank debt and a bridge facility (to be provided by the lender in lieu of a bond financing if the capital markets are not available at the time the acquisition is consummated); an engagement letter, in which the sponsor engages the investment banks to underwrite the bonds on behalf of the issuer; and a fee letter, which sets forth the various fees to be paid to the investment banks in connection with the financing.


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The Ascent of Money: A Financial History of the World by Niall Ferguson

Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, business cycle, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, commoditize, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, iterative process, John Meriwether, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour mobility, Landlord’s Game, liberal capitalism, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, Naomi Klein, negative equity, Nelson Mandela, Nick Leeson, Northern Rock, Parag Khanna, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, stocks for the long run, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, undersea cable, value at risk, Washington Consensus, Yom Kippur War

One of the most experienced investors there went so far as to suggest to the organizers that they ‘dispense altogether with an outside speaker next year, and instead offer a screening of Mary Poppins’.6 Yet the mention of Mary Poppins stirred a childhood memory in me. Julie Andrews fans may recall that the plot of the evergreen musical revolves around a financial event which, when the film was made in the 1960s, already seemed quaint: a bank run - that is, a rush by depositors to withdraw their money - something not seen in London since 1866. The family that employs Mary Poppins is, not accidentally, named Banks. Mr Banks is indeed a banker, a senior employee of the Dawes, Tomes Mousley, Grubbs, Fidelity Fiduciary Bank. At his insistence, the Banks children are one day taken by their new nanny to visit his bank, where Mr Dawes Sr. recommends that Mr Banks’s son Michael deposit his pocket-money (tuppence).

Prior to the 1390s, it might legitimately be suggested, the Medici were more gangsters than bankers: a small-time clan, notable more for low violence than for high finance. Between 1343 and 1360 no fewer than five Medici were sentenced to death for capital crimes.31 Then came Giovanni di Bicci de’ Medici. It was his aim to make the Medici legitimate. And through hard work, sober living and careful calculation, he succeeded. In 1385 Giovanni became manager of the Roman branch of the bank run by his relation Vieri di Cambio de’ Medici, a moneylender in Florence. In Rome, Giovanni built up his reputation as a currency trader. The papacy was in many ways the ideal client, given the number of different currencies flowing in and out of the Vatican’s coffers. As we have seen, this was an age of multiple systems of coinage, some gold, some silver, some base metal, so that any long-distance trade or tax payment was complicated by the need to convert from one currency to another.

By the time money has been deposited at three different student banks, M0 is equal to $100 but M1 is equal to $271 ($100 + $90 + $81), neatly illustrating, albeit in a highly simplified way, how modern fractional reserve banking allows the creation of credit and hence of money. The professor then springs a surprise on the first student by asking for his $100 back. The student has to draw on his reserves and call in his loan to the second student, setting off a domino effect that causes M1 to contract as swiftly as it expanded. This illustrates the danger of a bank run. Since the first bank had only one depositor, his attempted withdrawal constituted a call ten times larger than its reserves. The survival of the first banker clearly depended on his being able to call in the loan he had made to his client, who in turn had to withdraw all of his deposit from the second bank, and so on. When making their loans, the bankers should have thought more carefully about how easily they could call back the money - essentially a question about the liquidity of the loan.


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Finance and the Good Society by Robert J. Shiller

Alvin Roth, bank run, banking crisis, barriers to entry, Bernie Madoff, buy and hold, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, income inequality, information asymmetry, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Myron Scholes, Nelson Mandela, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, Right to Buy, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, Thales and the olive presses, Thales of Miletus, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, zero-sum game, Zipcar

So everyone can make deposits that are backed by illiquid investments yet have their individual deposits remain highly liquid. It seems almost a miracle. This system usually works as intended, though it is vulnerable to sudden panic or bank runs: if people begin to distrust the bank, too many of them may ask to withdraw their money at one time and they will exhaust the bank’s supply of liquid funds.1 Even then, and even if there is no deposit insurance, if the government allows the bank to suspend liquidity temporarily, then depositors will still in all likelihood eventually get paid most of what they were owed, as the bank converts some of its illiquid holdings into cash. Bank regulators in modern times attempt to further reduce the problem of bank runs by demanding that banks maintain an adequate amount of reserves (cash in the vault or deposits at other banks, to make good immediately on any sudden withdrawals by depositors) and of capital (the total cushion of assets, after subtracting liabilities, available to make good on promises to depositors), so that they will not put the government in the position of having to bail out the banks.

That is, among the individuals inducted into the army between 1982 and 2001, those who had higher IQ scores had higher Sharpe ratios for their 2000 portfolios, controlling for other factors, re ecting greater exposure to small-cap and value stocks and better diversification. Grinblatt et al. (2011). 10. Kat and Menexe (2003). 11. Kaplan and Schoar (2005). 12. Berk and Green (2004). 13. Bogle (2009): 47. 14. Levine (1997). 15. French (2008). 16. Goetzmann et al. (2002). 17. Dugan et al. (2002). 18. Dugan (2005). 19. Acharya et al. (2010). 20. Kaufman (2005): 313. 21. Bernasek (2010): 48. Chapter 3. Bankers 1. Diamond and Dybvig (1983) lay out the issue of bank runs as a problem of multiple equilibria in a model of banks as creators of liquidity, thereby providing both a clear rationale for the existence of banks and an understanding of their vulnerabilities. 2. http://fraser.stlouisfed.org/publications/bms/issue/61/download/130/section10.p Table 130. 3. There were some forms of capital requirements before 1982, but no national systematic and regular enforcement of them for banks until then.

“Observations Made in a Tour in Swisserland [sic] . ” Columbian Magazine 2(12):688–93. Della Vigna, Stefano, John A. List, and Ulrike Malmendier. 2011. “Testing for Altruism and Social Pressure.” Unpublished paper, Department of Economics, University of California at Berkeley. De Waal, Frans. 1990. Peacemaking among Primates. Cambridge, MA: Harvard University Press. Diamond, Douglas, and Philip Dybvig. 1983. “Bank Runs, Deposit Insurance, and Liquidity.” Journal of Political Economy 91(3):401–19. Dixit, Avinash K., and Robert S. Pindyck. 1994. Investment under Uncertainty. Princeton, NJ: Princeton University Press. Djilas, Milovan. 1982 [1957]. The New Class: An Analysis of the Communist System. New York: Harcourt Brace Jovanovich. Douglas, William O. 1940. Democracy and Finance. New Haven, CT: Yale University Press.


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The Euro and the Battle of Ideas by Markus K. Brunnermeier, Harold James, Jean-Pierre Landau

Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, battle of ideas, Ben Bernanke: helicopter money, Berlin Wall, Bretton Woods, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, collective bargaining, credit crunch, Credit Default Swap, currency peg, debt deflation, Deng Xiaoping, different worldview, diversification, Donald Trump, Edward Snowden, en.wikipedia.org, Fall of the Berlin Wall, financial deregulation, financial repression, fixed income, Flash crash, floating exchange rates, full employment, German hyperinflation, global reserve currency, income inequality, inflation targeting, information asymmetry, Irish property bubble, Jean Tirole, Kenneth Rogoff, Martin Wolf, mittelstand, money market fund, Mont Pelerin Society, moral hazard, negative equity, Neil Kinnock, new economy, Northern Rock, obamacare, offshore financial centre, open economy, paradox of thrift, pension reform, price stability, principal–agent problem, quantitative easing, race to the bottom, random walk, regulatory arbitrage, rent-seeking, reserve currency, road to serfdom, secular stagnation, short selling, Silicon Valley, South China Sea, special drawing rights, the payments system, too big to fail, union organizing, unorthodox policies, Washington Consensus, WikiLeaks, yield curve

The German discussion was dominated by the perception that a great deal of the liabilities of the Cyprus banking system consisted of the assets of Russian oligarchs, which constituted a possible criminal or even security threat, and hence required no special protection by European governments. For Berlin, there was little that constituted systemic risk in the Cyprus situation, and German officials complained that “if Cyprus is systemic, then everything is systemic.” By contrast, many policy makers in France, but also in Italy and Spain, feared that penalization of Cypriot depositors might lead to a bank run in other countries (including their own). The Cyprus crisis changed Europeans’ attitude toward bailouts. The new chair of the Eurogroup, the Netherlands finance minister Jeroen Dijss-elbloem, spoke of the Cyprus approach as offering a “template.” Even outside Europe, it looked like an attractive solution to the problems created in the wake of the financial crisis. For instance, the influential governor of the Bank of Canada Mark Carney deduced that his country should move away from bailouts, and in May 2013, Canada launched a “bail-in regime.”

A second important facet of cross-country flows in the euro area is that much of the funding came in the form of wholesale, interbank funding. Because of this funding structure, capital flows into the periphery could dry up and reverse quickly. Still, this is not a feature unique to international capital flows, as much within-country funding is also interbank and wholesale. Just consider, for example, Northern Rock, a UK bank that suffered a bank run in 2007. It was reliant on wholesale funding, and it was precisely this reliance that made Northern Rock so vulnerable to a run. Other UK banks also relied on wholesale funding, but the larger banks had European subsidiaries that had access to ECB liquidity at a time when the Bank of England was reluctant to provide liquidity out of moral hazard concerns. Do cross-border capital flows within a currency union deserve special attention because they can lead to inefficient investment and misallocation?

Crisis Management: Fiscal Policy and Regulatory Measures Fiscal policy measures strain the government’s fiscal budget: (1) Government guarantees only do so when called upon, (2) direct bank recapitalization schemes, for example through equity injections, do so for sure, (3) bail-ins force other investors to share the burden, while (4) recapitalization through other means have no direct, but might have indirect, costs. Government Guarantees Governments may decide to issue blanket guarantees for domestic bank assets. If this guarantee is credible, then any liquidity-related problems will immediately dissipate. Government guarantees of this sort are generally not viewed as a crisis measure; basic kinds of deposit insurance are in place in many advanced economies, motivated as a means of staving off bank-run dynamics and so ensuring coordination on the good equilibrium. The Irish crisis experience, however, shows that extended government guarantees may also function as a crisis response tool that goes beyond fixing a liquidity problem and the taxpayer eventually may have to foot the bill. At the height of the financial crisis in 2008, the Irish government extended existing deposit insurance schemes to a two-year blanket guarantee for the liabilities of all Irish banks, including all sorts of deposits, senior unsecured debt, subordinated debt, and asset-covered securities.


The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good by William Easterly

airport security, anti-communist, Asian financial crisis, bank run, banking crisis, Bob Geldof, Bretton Woods, British Empire, call centre, clean water, colonial exploitation, colonial rule, Edward Glaeser, end world poverty, European colonialism, failed state, farmers can use mobile phones to check market prices, George Akerlof, Gunnar Myrdal, Hernando de Soto, income inequality, income per capita, Indoor air pollution, invisible hand, Kenneth Rogoff, laissez-faire capitalism, land reform, land tenure, Live Aid, microcredit, moral hazard, Naomi Klein, Nelson Mandela, publication bias, purchasing power parity, randomized controlled trial, Ronald Reagan, Scramble for Africa, structural adjustment programs, The Fortune at the Bottom of the Pyramid, the scientific method, The Wealth of Nations by Adam Smith, transaction costs, War on Poverty, Xiaogang Anhui farmers

In 1995, in return for support of the “pro-market reformer” Boris Yeltsin, for example, Russian tycoons snatched up the valuable firms at bargain-basement prices. At the auction of the prize oil company Yukos, the Yeltsin government excluded bids from foreign buyers, eliminating most deep-pocket competitors. The Yeltsin government also allowed the banks running the auction to bid on the properties they themselves were auctioning. So Mikhail Khodorkovsky could bid on the auction of Yukos, even though he owned the bank running the auction, Menatep. Russian privatization chief Alfred Kokh alleged that Khodorkovsky used the money of Yukos itself to bid for Yukos, perhaps by pledging future oil deliveries in return for loans. He managed to buy 77 percent of Yukos shares for $309 million in December 1995.8 This was a pretty good deal for a company that by 2003 reached a market valuation of $30 billion.9 Khodorkovsky joined the top ranks on Forbes ’s annual billionaires list.

The IMF loan is conditional upon the government’s getting its finances in order so it can pay the loan back quickly. The IMF’s approach is simple. A poor country runs out of money when its central bank runs out of dollars. The central bank needs an adequate supply of dollars for two reasons. First, so that residents of the poor country who want to buy foreign goods can change their domestic money (let’s call it pesos) into dollars. Second, so those poor-country residents, firms, or governments who owe money to foreigners can change their pesos into dollars with which to make debt repayments to their foreign creditors. What makes the central bank run out of dollars? The central bank not only holds the nation’s official supply of dollars (foreign exchange reserves), it also makes loans to the government and supplies the domestic currency for the nation’s economy.


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The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order by Paul Vigna, Michael J. Casey

Airbnb, altcoin, bank run, banking crisis, bitcoin, blockchain, Bretton Woods, buy and hold, California gold rush, capital controls, carbon footprint, clean water, collaborative economy, collapse of Lehman Brothers, Columbine, Credit Default Swap, cryptocurrency, David Graeber, disintermediation, Edward Snowden, Elon Musk, Ethereum, ethereum blockchain, fiat currency, financial innovation, Firefox, Flash crash, Fractional reserve banking, hacker house, Hernando de Soto, high net worth, informal economy, intangible asset, Internet of things, inventory management, Joi Ito, Julian Assange, Kickstarter, Kuwabatake Sanjuro: assassination market, litecoin, Long Term Capital Management, Lyft, M-Pesa, Marc Andreessen, Mark Zuckerberg, McMansion, means of production, Menlo Park, mobile money, money: store of value / unit of account / medium of exchange, Nelson Mandela, Network effects, new economy, new new economy, Nixon shock, offshore financial centre, payday loans, Pearl River Delta, peer-to-peer, peer-to-peer lending, pets.com, Ponzi scheme, prediction markets, price stability, profit motive, QR code, RAND corporation, regulatory arbitrage, rent-seeking, reserve currency, Robert Shiller, Robert Shiller, Ross Ulbricht, Satoshi Nakamoto, seigniorage, shareholder value, sharing economy, short selling, Silicon Valley, Silicon Valley startup, Skype, smart contracts, special drawing rights, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, supply-chain management, Ted Nelson, The Great Moderation, the market place, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, Turing complete, Tyler Cowen: Great Stagnation, Uber and Lyft, uber lyft, underbanked, WikiLeaks, Y Combinator, Y2K, zero-sum game, Zimmermann PGP

The Chinese government might bar its banks from handling bitcoin-related transaction services or declare that only the yuan be used within the nation’s borders, but it can’t shut down bitcoin, which resides nowhere and everywhere. The same challenge faces any government. This was appealing to a marginal but not insignificant subculture of passionate, highly motivated activists who are skeptical of central-bank-run fiat money. More broadly, it was consistent with a trend toward decentralization and individual empowerment in the broader economy, a world in which people are renting out their sofas to paying guests, selling solar-generated power back to the grid, and drawing their news from decentralized forums such as Twitter. In this environment and faced with what Nakamoto had proposed, an increasing number of people came to trust that his system worked.

That larger neighbor had become the basket case of the European Union, which had just forced the government in Athens to impose a “haircut,” or mandated losses, on its investors. The EU did this to ensure that private-sector investors who’d made risky bets on Greece shouldered some of the burden of the bailout that German and other euro-zone taxpayers were bearing. Cyprus’s overleveraged banks were an unintended casualty of that and were now faced with the terrifying threat of a bank run by their large Russian depositors. The dramatic solution, one endorsed by Germany and its EU partners, who were equally reluctant to bail out Russian oligarchs, was that the government in Nicosia would freeze deposits and confiscate 10 percent of them to pay for a bank bailout. This unprecedented step sent shock waves around the world. “If they can do that there, they can do it anywhere,” yelled Mark McGowan, a London cabbie famous for his profanity-laced YouTube videos, where he rants about topical matters under the moniker chunkymark, all delivered from his cab.

Interacting on bitcoin forums with other bitcoiners via his MagicalTux username, Karpelès pulled off a stunt to prove Mt. Gox’s solvency. He told his online correspondents to keep their eyes on two particular bitcoin addresses via a live, online blockchain monitor and that he would transfer 424,242.424242* bitcoins between them. It was the cryptocurrency equivalent of the old “wall of money” that bank managers of years past would put behind their tellers to dissuade panicked depositors from engaging in a bank run. After he moved such a large amount of coins, the maneuver had its desired effect. Such a massive handover of bitcoins suggested Mt. Gox was more flush than everyone feared. Three years later the blockchain-embedded history of this exercise, in which Karpelès effectively identified those addresses as belonging to Mt. Gox wallets, provided the starting point from which a posse of bitcoiners would trace the blockchain to discover two hundred thousand coins that were still present in Mt.


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Bitcoin Billionaires: A True Story of Genius, Betrayal, and Redemption by Ben Mezrich

"side hustle", airport security, Albert Einstein, bank run, Ben Horowitz, bitcoin, blockchain, Burning Man, buttonwood tree, cryptocurrency, East Village, El Camino Real, Elon Musk, family office, fault tolerance, fiat currency, financial innovation, game design, Isaac Newton, Marc Andreessen, Mark Zuckerberg, Menlo Park, Metcalfe’s law, new economy, offshore financial centre, paypal mafia, peer-to-peer, Peter Thiel, Ponzi scheme, QR code, Ronald Reagan, Ross Ulbricht, Sand Hill Road, Satoshi Nakamoto, Schrödinger's Cat, self-driving car, side project, Silicon Valley, Skype, smart contracts, South of Market, San Francisco, Steve Jobs, transaction costs, zero-sum game

Marina realized that the crowd was in front of one of the many bank branches that speckled the beachside town; she immediately recognized the bright red signs of LAIKA BANK, the country’s second largest. Most of the storefront was brick, with large glass windows, a double wooden door, and three ATM machines perched on the stone sidewalk out front. Marina counted at least thirty people lined up at the machines, not pushing and shoving yet but clearly restless. “What is this?” Marina said. “It’s the bank run before the bank run.” Marina realized she probably should have been paying more attention during the protracted conversation the night before. She knew that things were bad, that Cyprus, like many of the more economically challenged nations of the EU, was in major debt—and that the continent’s financial leaders had been meeting in Brussels to figure out how to handle the situation. But beyond that, she was no expert; Cyprus was out of money, but its economy hadn’t totally cratered like nearby Greece, which was in the process of being bailed out by the EU through an austerity package—lowered salaries and entitlements across the board, fired government employees, shuttered businesses—that had led to riots in the streets of Athens.

And all bank deposits were only insured to the tune of $250,000. “More than twenty thousand account holders at Laika, the second largest bank in Cyprus, are going to have half of their savings taken away,” Tyler said. “The Bank of Cyprus, the largest bank, is going to take almost fifty percent of all deposits over a hundred thousand.” “They’re calling it a tax, or levy,” Cameron said. “They’re closing all the banks to keep it from turning into a bank run.” “Look at this picture,” Tyler said. “This is a mob outside one of the banks. A bunch of people got hold of a bulldozer. It looks like they’re going to try to get inside.” “Nobody is going to feel safe keeping their money in an EU bank after this. No one is going to feel safe keeping money in any bank, period.” Tyler looked at him. The entire arena seemed to lurch under his feet as the DJ on the stage hit keys on his computer, launching off an artillery battalion of synthetic drumbeats.


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The Full Catastrophe: Travels Among the New Greek Ruins by James Angelos

bank run, Berlin Wall, centre right, death of newspapers, Fall of the Berlin Wall, ghettoisation, illegal immigration, income inequality, moral hazard, plutocrats, Plutocrats, urban planning

Global financial markets convulsed in fear of an impending win for Syriza, whose young, necktie-averse leader, a former communist youth activist, threatened to renege on Greece’s debt obligations. German politicians renewed public deliberations over whether it would be best to eject Greece from the eurozone. “Grexit” became a frequently used word. Greeks started removing cash from their bank accounts over fears that ATM machines would soon start spitting out worthless drachmas. The severe bank run that resulted and the deepening cycle of doubt did not create an environment conducive to economic recovery, which of course made Greece’s problems even worse. In the next election, New Democracy, which depicted itself as the safe choice for voters wishing to remain in the euro, eked out a narrow victory, and on account of a parliamentary seat bonus afforded to the party with the plurality of votes, was able to form a coalition government that included its former rival, PASOK.

This was particularly the case in Germany, where ruling politicians demanded Greece honor the existing bailout agreement and questioned how its government could renege on the deal and still ask for money or debt relief, which would come at a cost to German and other European taxpayers. Given the discordant impasse between the two sides, doubts over Greece’s future in the eurozone once again intensified. “Grexit” reemerged in the lexicon, and even as many Greeks heralded Syriza’s bold stance toward the Troika, concerned Greek depositors began transferring their euros out of the country, stoking fears of another crippling bank run. Meanwhile, the state’s income rapidly eroded as many Greek taxpayers, anticipating Syriza would ease their burden, simply stopped paying, leaving the new government, just weeks in office, struggling desperately to make its debt payments and avoid default. Running out of time and money, Syriza’s leaders—like their predecessors—were compelled to yield to the creditors. In exchange for limited concessions, Greece’s new government agreed to extend the bailout program for some months—and along with it, the reviled mnimonio—though the agreement contained enough ambiguity to allow Greek authorities to deny this was the case.

In one of the pictures, a young Mavrommatis in an embroidered dress and white shoes stood next to the restaurant entrance looking happily at the camera while her handsome, grinning father embraced her. The restaurant had been in the family for four generations, and despite Greece’s economic problems, business still seemed to be going okay. The instability of the previous few months—two parliamentary elections within a month, massive protests, a bank run over fears the country would exit the euro—were developments that tended to discourage foreign visitors, and Greece that year suffered the consequences with regard to tourism. Still, the island received a loyal mix of affluent Athenians and foreign returnees. When Ilias joined me at the table, he told me he didn’t know why the police wrote them up for what he said were eleven violations. The restaurant, he said, had only three tables at the time for which there were open orders, and receipts for those were on the way.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

activist fund / activist shareholder / activist investor, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, business cycle, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, God and Mammon, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, plutocrats, Plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

This leads to a curious position where both depositor and borrower are entitled to control over the same funds simultaneously. If depositors lose confidence in the bank and demand their money back all at once, the bank will be unable to meet its obligations. A run on deposits will follow. Such crises of confidence started in northern Italy in the late Middle Ages when this so-called fractional reserve banking became the norm. A vivid description of how bank runs arose comes from a contemporary Venetian account in the sixteenth century: The following year, 1584, I heard of the failure of the Pisani and Tiepolo bank for a very large sum of money. This was caused chiefly by the bankruptcy of one Andrea da l’Osta, a Tuscan, a Pisan, and a very rich merchant, who had lived in our city for many years. He had built up much credit by his many business transactions, but in truth it was based on his reputation alone and not upon his capital, for this market and the city of Venice are naturally very much inclined to love and trust in appearances.

The bank kept going for a few days, paying them off as best it could, but in the end the crowd of creditors increased and the bank collapsed and failed, to the detriment of numberless people and great damage to this market, which was without a bank for four years, so that business shrank to an unbelievable extent. The Republic felt the effects of this, and took very extensive measures, but to no avail.36 Today, bank runs usually take a different form. Big depositors such as companies, pension funds and other financial institutions simply decide not to renew lending lines or certificates of deposit, so an ailing bank finds that its sources of funds dry up. Notwithstanding that, the British bank Northern Rock actually experienced in 2007 an old-style run in which worried retail depositors queued up outside branches to withdraw their money.

Wilson) 1, 2 Alberti, Leon Battista 1 Alessandri, Piergiorgio 1 Allen, Maurice 1 Ambassadors, The (Henry James) 1 Americans for Tax Reform 1 Anatomy of Change-Alley (Daniel Defoe) 1 Angell, Norman 1 Anglosphere 1, 2 Arab Spring 1 Aramaic 1 arbitrage 1 Argentina 1 Aristotle 1, 2, 3, 4, 5, 6, 7, 8, 9 art 1 Asian Tiger economies 1 Atlas Shrugged (Ayn Rand) 1 Austen, Jane 1 Austrian school 1 aviation 1 Babbitt (Sinclair Lewis) 1 Bair, Sheila 1 Balloon Dog (Orange) (sculpture) 1 Balzac 1 Bank for International Settlements 1, 2, 3, 4, 5, 6 Bank of England 1, 2, 3, 4, 5 bank runs 1 bankers 1, 2 bankruptcy laws 1, 2 Banks, Joseph 1 Banksy 1 Barbon, Nicholas 1, 2, 3 Bardi family 1 Barings 1 Baruch, Bernard 1, 2 base metal, transmutation into gold 1 Basel regulatory regime 1, 2, 3 Baudelaire, Charles 1 Baum, Frank 1 behavioural finance 1 Belgium 1, 2 Bell, Alexander Graham 1 Benjamin, Walter 1 Bernanke, Ben 1, 2, 3 Bi Sheng 1 Bible 1 bimetallism 1 Bismarck, Otto von 1 Black Monday (1987) 1 black swans 1 Blake William 1, 2, 3 Bloch, Marcel 1 Bloomsbury group 1, 2 Boccaccio 1 bond market 1 bonus culture 1 Bootle, Roger 1 Boston Tea Party 1 Boswell, James 1 Boulton, Matthew 1 Bowra, Maurice 1 Brandeis, Louis 1 Bretton Woods conference 1 British Land (property company) 1 British Rail pension fund 1 Brookhart, Smith 1, 2 Brunner, Karl 1 Bryan, William Jennings 1 Bubble Act (Britain 1720) 1 bubbles 1, 2, 3 Buchanan, James 1 Buffett, Warren 1, 2, 3 Buiter, Willem 1 Burdett, Francis 1 van Buren, Martin 1 Burke, Edmund 1, 2 Burns, Robert 1 Bush, George W. 1, 2 Butler, Samuel 1 Candide (Voltaire) 1 Carlyle, Thomas 1, 2, 3 Carnegie, Andrew 1 Carville, James 1 cash nexus 1 Cash Nexus, The (Niall Ferguson) 1 Cassel, Ernest 1, 2 Catholic Church 1, 2, 3 Cecchetti, Stephen 1 Centre for the Study of Capital Market Dysfunctionality, (London School of Economics) 1 central bankers 1 Cervantes 1 Chamberlain, Joseph 1 Chancellor, Edward 1 Chapter 11 bankruptcy 1 Charles I of England 1, 2 Charles II of England 1 Chaucer 1 Cheney, Dick 1 Chernow, Ron 1 Chicago school 1, 2 Child & Co. 1 China 1, 2 American dependence on 1, 2 industrialisation 1, 2, 3 manufacturing 1 paper currency 1 Christianity 1, 2, 3, 4, 5 Churchill, Winston 1 Cicero 1, 2 Citizens United case 1 Cleveland, Grover 1 Clyde, Lord (British judge) 1 Cobden, Richard 1, 2, 3, 4 Coggan, Philip 1 Cohen, Steven 1 Colbert, Jean-Baptiste 1, 2 Cold War 1 Columbus, Christopher 1 commodity futures 1 Companies Act (Britain 1862) 1 Condition of the Working Class in England (Engels) 1 Confucianism 1, 2, 3 conquistadores 1 Constitution of Liberty, The (Friedrich Hayek) 1 Coolidge, Calvin 1, 2, 3 Cooper, Robert 1 copyright 1 Cort, Cornelis 1 Cosimo the Elder 1 crash of 1907 1 crash of 1929 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 creative destruction 1, 2 credit crunch (2007) 1, 2, 3 cum privilegio 1 Cyprus 1, 2 Dale, Richard 1, 2 Dante 1 Darwin, Erasmus 1 Das Kapital (Karl Marx) 1 Dassault, Marcel 1 Daunton, Martin 1 Davenant, Charles 1, 2, 3 Davies, Howard 1 debt 1 debt slavery 1 Decameron (Boccaccio) 1 Defoe, Daniel 1, 2, 3, 4, 5, 6, 7, 8 Dell, Michael 1 Deng Xiaoping 1, 2 derivatives 1 Deserted Village, The (Oliver Goldsmith) 1, 2, 3 Devil Take the Hindmost (Edward Chancellor) 1 Dickens, Charles 1, 2, 3, 4, 5, 6, 7, 8, 9 portentously named companies 1 Die Juden und das Wirtschaftsleben (Werner Sombart) 1 A Discourse of Trade (Nicholas Barbon) 1 Ding Gang 1 direct taxes 1, 2 Discorsi (Machiavelli) 1 diversification 1 Dodd–Frank Act (US 2010) 1, 2, 3 ‘dog and frisbee’ speech 1 dot.com bubble 1, 2, 3, 4 Drayton, Harley 1 Dumas, Charles 1, 2 Dürer, Albrecht 1 Duret, Théodore 1, 2 Dutch East India Company 1 Duttweiler, Gottlieb 1 Dye, Tony 1 East of Eden (film version) 1 Economic Consequences of the Peace (Keynes) 1, 2 Edison, Thomas 1, 2 efficient market hypothesis 1 electricity 1 Eliot, T.


pages: 294 words: 89,406

Lying for Money: How Fraud Makes the World Go Round by Daniel Davies

bank run, banking crisis, Bernie Madoff, bitcoin, Black Swan, Bretton Woods, business cycle, business process, collapse of Lehman Brothers, compound rate of return, cryptocurrency, financial deregulation, fixed income, Frederick Winslow Taylor, Gordon Gekko, high net worth, illegal immigration, index arbitrage, Nick Leeson, offshore financial centre, Peter Thiel, Ponzi scheme, price mechanism, principal–agent problem, railway mania, Ronald Coase, Ronald Reagan, short selling, social web, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, time value of money, web of trust

This was how the scheme managed to continue rather than collapsing at the first maturity date. Having bought time, Ponzi was as industrious as he was unscrupulous in using it. He set out to try to use his lies and fake assets to take control of some real wealth. Those who live by the sword tend to die by it. Ponzi’s scheme was fated to collapse in the equivalent of a bank run, but while he was operating it he was not averse to using threats of bank runs as a weapon of his own. At the height of his scheme, the Securities Exchange Corporation’s cash balances (which were held on hand as short-term bank deposits, ostensibly to keep them ready to pay cash for postal coupons) were a significant percentage of the local money supply in Boston and its surrounding area. For a number of large and important banks, Ponzi’s deposits were a greater sum than they could raise at short notice and were essential to their ability to maintain enough liquidity to sustain their operations.

Either point of view is defensible, because the S&L crisis was, in reality, at least two crises, and the policy measures which, partly successfully, aimed to solve the first arguably helped to bring about the second. The crisis had its roots in the 1970s and the attempt to tame inflation by raising interest rates. Savings and Loans (also known as ‘thrifts’) were a kind of small bank which had grown up in the pioneer era, taking deposits and making loans in a small local area. The legacy of bank runs and instability in the early days of the USA had, before the 1980s, left a legacy of mistrust of large or multi-branch operations, but the S&Ls had strict limits on what they could do and tended to operate in uncompetitive local markets. For this reason, it was felt that they didn’t need much scrutiny from bank examiners. The joke about their style of banking was always that they followed the 3-6-3 rule: pay 3 per cent on deposits, charge 6 per cent for loans and make sure you are on the golf course by 3 p.m.


pages: 312 words: 93,836

Barometer of Fear: An Insider's Account of Rogue Trading and the Greatest Banking Scandal in History by Alexis Stenfors

Asian financial crisis, asset-backed security, bank run, banking crisis, Big bang: deregulation of the City of London, bonus culture, capital controls, collapse of Lehman Brothers, credit crunch, Credit Default Swap, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, fixed income, game design, Gordon Gekko, inflation targeting, information asymmetry, interest rate derivative, interest rate swap, London Interbank Offered Rate, loss aversion, mental accounting, millennium bug, Nick Leeson, Northern Rock, oil shock, price stability, profit maximization, regulatory arbitrage, reserve currency, Rubik’s Cube, Snapchat, the market place, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, Y2K

By doing so, it is possible to reveal not only how and why LIBOR became so important in the first place, but also how and why it came to be perceived as an objective number that was impossible to manipulate. In short, how LIBOR became an illusion.3 *** A financial crisis tends to be associated with fears of a bank run. If customers desperately begin to withdraw their deposits from a bank, it can quickly turn into a self-fulfilling prophecy. Because if you think that others will become afraid that the bank will run out of cash, it might be rational to empty your own savings account first. The typical illustration of a bank run is a picture of a very long queue outside a bank branch or an ATM. The images look similar, whether they are black and white and taken in New York or Berlin during the 1930s, outside Northern Rock in Newcastle in 2007, or somewhere in Greece during the summer of 2015.

Likewise, earnings reports and other financial statements were not published frequently. The individual LIBOR quotes, by contrast, were announced daily and therefore served as snapshots of the perceived creditworthiness of the banks. A unique thing with banks is that they inherently always have a desire to appear ‘good and sound’. If depositors lose confidence in the ability of the bank to meet its obligations, there could be a bank run around the corner and the bank could face the risk of being wiped out altogether. Even the slightest of suspicions could cause a sharp decline in the stock price. The problem with the LIBOR fixing mechanism resulted from the individual LIBOR rates being public knowledge (i.e. fully transparent) at the same time as the actual funding rate was private knowledge (i.e. secret). LIBOR banks did not have to prove that the rates they were submitting were, in fact, rates at which they were able to borrow.


pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

"Robert Solow", Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, banks create money, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial innovation, fixed income, friendly fire, full employment, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, market clearing, market fundamentalism, McMansion, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, price mechanism, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, working-age population, yield curve, Yogi Berra

The real wake-up call didn’t come until August 9, 2007, when BNP Paribas, a huge French bank, halted withdrawals on three of its subprime mortgage funds—citing as its reason that “the complete evaporation of liquidity in certain market segments of the US securitization market has made it impossible to value certain assets fairly.” Loose translation: Dear Customer, you can’t get access to the money you thought was yours, and we have no idea how much money that is. To people acquainted with American history, Paribas’ announcement brought to mind the periodic “suspensions of specie payments” in the nineteenth century—times when some prominent bank precipitated bank runs by refusing to exchange its notes for gold or silver. The big French bank had just refused to exchange its fund shares for cash. Whether you were French or American, the signal was clear: It was time to panic. And markets dutifully did so, all over the world. At some point, and in this case it didn’t take long, the interplay of falling asset values with high leverage starts calling into question the solvency of heavily exposed financial firms like Bear and Paribas.

Back in 1873, Walter Bagehot, the sage of central banking, had instructed central banks on what to do in a liquidity crisis. His triad was lend freely, against good collateral, but at a penalty rate. Why? Because the acute shortage of liquidity in a panic can push even solvent institutions over the edge. Customers come in demanding their money. If the banks don’t have enough cash on hand, word gets around, and bank runs start sprouting up everywhere. The disease is highly contagious. By serving as the lender of last resort, the central bank is supposed to stop all that from happening. And every central banker in the world knew Bagehot’s catechism. So that’s basically what most of them did in August 2007. In fact, one can argue that the ECB stuck with the Bagehot script until late 2011. The ECB refused to cut its interest rates until October 2008 (yes, that’s 2008, not 2007), and even then it gave ground grudgingly.

At its September 18 meeting, the FOMC qualified its view that “the tightening of credit conditions has the potential to . . . restrain economic growth” by adding that “some inflation risks remain.” It was a finely balanced assessment of risks—far too balanced, given the emerging realities. Just five days earlier, the Bank of England had intervened massively to save Northern Rock, a huge savings institution, from the first bank run in Britain since 1866.* Things were coming unglued in England. Our problems here were strikingly similar. Could we be far behind? While the Fed’s speed made the ECB look like the proverbial tortoise watching the hare, this particular hare wasn’t actually running that fast. After its 50-basis-point rate cut on September 18, 2007, the Fed waited another six weeks—until its next regularly scheduled meeting—to move again.


pages: 585 words: 151,239

Capitalism in America: A History by Adrian Wooldridge, Alan Greenspan

"Robert Solow", 2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, Affordable Care Act / Obamacare, agricultural Revolution, air freight, Airbnb, airline deregulation, American Society of Civil Engineers: Report Card, Asian financial crisis, bank run, barriers to entry, Berlin Wall, Bonfire of the Vanities, Bretton Woods, British Empire, business climate, business cycle, business process, California gold rush, Charles Lindbergh, cloud computing, collateralized debt obligation, collective bargaining, Corn Laws, corporate governance, corporate raider, creative destruction, credit crunch, debt deflation, Deng Xiaoping, disruptive innovation, Donald Trump, edge city, Elon Musk, equal pay for equal work, Everybody Ought to Be Rich, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, fixed income, full employment, George Gilder, germ theory of disease, global supply chain, hiring and firing, income per capita, indoor plumbing, informal economy, interchangeable parts, invention of the telegraph, invention of the telephone, Isaac Newton, Jeff Bezos, jimmy wales, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Kenneth Rogoff, Kitchen Debate, knowledge economy, knowledge worker, labor-force participation, Louis Pasteur, low skilled workers, manufacturing employment, market bubble, Mason jar, mass immigration, means of production, Menlo Park, Mexican peso crisis / tequila crisis, minimum wage unemployment, mortgage debt, Myron Scholes, Network effects, new economy, New Urbanism, Northern Rock, oil rush, oil shale / tar sands, oil shock, Peter Thiel, plutocrats, Plutocrats, popular capitalism, post-industrial society, postindustrial economy, price stability, Productivity paradox, purchasing power parity, Ralph Nader, Ralph Waldo Emerson, RAND corporation, refrigerator car, reserve currency, rising living standards, road to serfdom, Robert Gordon, Ronald Reagan, Sand Hill Road, savings glut, secular stagnation, Silicon Valley, Silicon Valley startup, Simon Kuznets, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, sovereign wealth fund, stem cell, Steve Jobs, Steve Wozniak, strikebreaker, supply-chain management, The Great Moderation, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, total factor productivity, trade route, transcontinental railway, tulip mania, Tyler Cowen: Great Stagnation, union organizing, Unsafe at Any Speed, Upton Sinclair, urban sprawl, Vannevar Bush, War on Poverty, washing machines reduced drudgery, Washington Consensus, white flight, wikimedia commons, William Shockley: the traitorous eight, women in the workforce, Works Progress Administration, Yom Kippur War, young professional

Gold withdrawals from the Federal Reserve Bank of New York surged, reducing the Fed’s gold balance far below the statutorily required 40 percent of Federal Reserve notes to just 24 percent (the Fed then suspended the gold reserve requirements). As of the close of business on March 4, 1933, the banks in thirty-five of the forty-eight states had declared bank holidays, according to an estimate by Allan Meltzer of Carnegie Mellon University. On March 5, FDR, as his first order of business, closed all banks under an obscure federal mandate. Closing banks was easier than reopening them again without triggering a resumption of bank runs. FDR discovered that his incoming administration didn’t have the capability to pull off this complicated task. Fortunately, Hoover’s team, led by the treasury secretary, Ogden Mills, and including Eugene Meyer, the chairman of the Federal Reserve, had devised a clever plan during its last year in office to reopen the banks without creating disruption: divide the banks into three classes according to their financial health; screen them thoroughly; and then restore them to regular operations in stages.

The act gave FDR the power to offer 100 percent guarantees for bank deposits, a point that the president hammered home in his first Fireside Chat, on March 12, a tour de force in which he explained the financial situation so well, Will Rogers quipped, that even a banker could understand it.26 Over the next few months, savers transferred billions of dollars of cash and gold from under their “mattresses” back into banks. FDR then created a Federal Bank Deposit Corporation (FIDC, later FDIC) that guaranteed individual bank deposits up to five thousand dollars (a figure that has subsequently been raised many times). The bank runs that had once been such a conspicuous feature of capitalism now became a rarity. He also reformed the securities industry by creating the Securities and Exchange Commission and forcing companies to publish detailed information, such as their balance sheets, profit and loss statements, and the names of their directors. Hitherto Wall Street had been dominated by a handful of insiders such as J. P.

Alas, Ozymandias had feet of clay: Lehman had invested massively in real estate and real-estate-related instruments, and when the housing market collapsed, so did the company. The financial crisis had been gathering strength long before Lehman’s collapse. In August 2007, BNP Paribas, a French bank, blocked withdrawals from its subprime mortgage funds. In September 2007, Britons lined up to take their money out of Northern Rock, a Newcastle-based bank, in the country’s first bank run since the collapse of Overend, Gurney and Company in 1866, a collapse that had inspired Walter Bagehot to write his great book on central banking, Lombard Street (1873). The Bank of England was eventually forced to take the bank into public ownership. On October 24, 2007, Merrill Lynch reported its biggest quarterly loss, $2.3 billion, in its ninety-three-year history. Lehman’s collapse was a turning point, tipping markets into panic, and alerting even the most lackadaisical observers of the global scene that something was going badly wrong.


pages: 840 words: 202,245

Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, business cycle, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, John Meriwether, Kitchen Debate, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, MITM: man-in-the-middle, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, new economy, North Sea oil, Northern Rock, oil shock, Paul Samuelson, Philip Mirowski, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

Its investors, stunned they could lose money at all, immediately began to withdraw what could have amounted to $5 billion from the fund. If investors in other money market funds followed, the consequences were unimaginable. Money market funds would sell their commercial paper willy-nilly. No Wall Street firm might survive. By the end of the week, the Treasury decided to guarantee the funds in all money market funds and stemmed the tide—what could have been a true bank run every bit as frightening as the bank runs of the early 1930s. Geithner and Paulson tried to get the stronger banks to merge with weaker ones, in particular, Goldman with Citigroup and JPMorgan Chase with Morgan Stanley, but the deals did not work out. To shore up its capital, Goldman separately lined up a $5 billion investment for preferred stock and warrants (rights to buy common stock in the future) from Warren Buffett.

By then, banks were not only making business and consumer loans in excess, but also selling stocks and bonds, running investment management companies, and creating new and highly speculative investment vehicles for individuals—as well as promoting their own stock prices. Such a credit boom and bust alone may not have resulted in the Depression but it contributed substantially to its severity. Thousands of banks failed in the early 1930s as savers withdrew their funds, fearing that the banks had no assets with which to pay them—a classic bank run. By 1932, one fourth of all U.S. banks had failed, and state after state imposed a moratorium on banking. Franklin Roosevelt, on taking office as president in 1933, declared a bank holiday, closing the deposit and withdrawal windows around the country temporarily. Roosevelt resisted pleas to nationalize the banks, but he and his advisers established comprehensive new regulations. Under Roosevelt, the federal government created the Federal Deposit In-surance Corporation (FDIC) to insure savers’ deposits in case of bank failure, giving the government further oversight of member banks.

Its high-profile chairman, Charles Mitchell, was forced to resign in 1933 in the depths of the banking panic, but the bank survived. Under Glass-Steagall, National City, like other major banks, was required to divest itself of its brokerage and underwriting arms, and do business only as a commercial bank, accepting deposits and making conservative purchases of government securities or cautious loans to business. The prestigious J.P. Morgan bank, run by the most influential financier of the age, was also separated from its investment banking arm, which took the name Morgan Stanley. The investment banks and brokerage firms were now regulated by the newly created Securities and Exchange Commission, whose first chairman was Joseph P. Kennedy, an aggressive financier himself and the father of a future president. The principal demand of the SEC was disclosure of far more information by investment banks about the firms for which they raised money, and other investor protections.


pages: 226 words: 59,080

Economics Rules: The Rights and Wrongs of the Dismal Science by Dani Rodrik

airline deregulation, Albert Einstein, bank run, barriers to entry, Bretton Woods, business cycle, butterfly effect, capital controls, Carmen Reinhart, central bank independence, collective bargaining, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Donald Davies, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, Fellow of the Royal Society, financial deregulation, financial innovation, floating exchange rates, fudge factor, full employment, George Akerlof, Gini coefficient, Growth in a Time of Debt, income inequality, inflation targeting, informal economy, information asymmetry, invisible hand, Jean Tirole, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labor-force participation, liquidity trap, loss aversion, low skilled workers, market design, market fundamentalism, minimum wage unemployment, oil shock, open economy, Pareto efficiency, Paul Samuelson, price stability, prisoner's dilemma, profit maximization, quantitative easing, randomized controlled trial, rent control, rent-seeking, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, school vouchers, South Sea Bubble, spectrum auction, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, trade liberalization, trade route, ultimatum game, University of East Anglia, unorthodox policies, Vilfredo Pareto, Washington Consensus, white flight

They were the object of study in models of varying complexity, including models based on perfectly rational, forward-looking investors (so-called rational bubbles). The financial crisis of 2008 had all the features of a bank run, and that, too, was a staple of economics. Models of self-fulfilling panic—a coordination failure in which individually rational withdrawals of credit lines produce collective irrationality in the form of a systemic drying up of liquidity—were well known to every student of economics, as were the conditions that facilitate such panics. The need for deposit insurance (coupled with regulation) to prevent bank runs was featured in all finance textbooks. A key pattern in the run up to the crisis was excessive risk taking by managers of financial institutions. Their compensation depended on it, but their behavior was not consistent with the interests of the banks’ shareholders.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, business cycle, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, John Meriwether, joint-stock company, Kenneth Rogoff, Kickstarter, labour market flexibility, light touch regulation, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, negative equity, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, plutocrats, Plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce, zero-sum game

Imagine, however, that you are a creditor or a merchant selling goods. Your debtor or customer offers to pay you back, not in pounds or dollars, but in Monopoly money. You might not regard this as payment at all. The fundamental worry of creditors is that governments can issue as much money as they like. Indeed, the concept is built into the rules of the Monopoly board game. The rules state that, ‘The Bank never goes broke. If the Bank runs out of money it may issue as much more as may be needed by merely writing on any ordinary paper.’ And in a sense, monopoly money is what we are all using. The monopolists in this case are governments, which permit the issue of notes and coins and give such currency their seal of approval in the form of seals, mottoes, or the queen’s head. The practice of putting an image of the sovereign on one side of the coin was a way of advertising his power, and the first coins were introduced by the kings of Lydia around 640 BC.

As well as being the guardians of monetary stability, central banks also acted as the lender of last resort for the domestic banking system. The nineteenth century had suffered a series of panics as individual banks had gone bust. It was a time of rudimentary accounting standards, lax financial regulation and no deposit insurance; all this gave too much scope to bank executives and too little comfort to bank depositors. At the slightest sign of trouble, there would be bank runs as depositors queued to get their money out. Such runs were quite rational. As seen in Chapter 2, banks lent out a lot more money than they had cash-in-hand; they relied on the fact that only a small number of depositors would want to withdraw cash at the same time. Their depositors had instant access to their money while the banks made loans which would only be repaid over time; in the jargon, they borrowed short and lent long.

Index AAA Status of US Adams, Douglas Adams, John Addison, Lord Adenauer, Konrad adjustable rate mortgages adulterating coins affluent society Afghanistan ageing populations agrarian revolution Ahamed, Liaquat AIG air miles Alaska Amazon.com Angell, Norman Anglo Irish Bank annuities Argentina Aristophanes Arkansas Asian crisis of 1997 – 8 asset prices assignats Athens Austen, Jane austerity Austria Austrian school Austro-Hungarian empire Aztecs B&Q baby boomers Babylon Bagehot, Walter bailouts balanced budget Baldwin II, King of Jerusalem Balfour, Arthur Bancor Bank for International Settlements bank notes Bank of England bank reserves bank runs bankruptcy codes Banque Generale Barclays Capital Baring, Peter Baring Brothers Barnes & Noble barter Basle Accords Bastiat, Frederic BCA Research BCCI bear markets Bear Stearns Beaverbrook, Lord Belgium Belloc, Hillaire Benn, Tony Benn, William Wedgwood Bernanke, Ben Bernholz, Peter bezant Big Bang Big Mac index bills of exchange bimetallism biofuels Bismarck, Otto von Black Death Black Monday black swan Blackstone Blair, Tony Blum, Léon BMW Bodencreditanstalt Bohemia Bolsheviks Bonnet, Georges Bootle, Roger Brady, Nicholas Brady bonds Brazil Bretton Woods system Brodsky, Paul Brooke, Rupert Brown, Gordon Bruning, Heinrich Brutus Bryan, William Jennings bubbles budget deficits budget surplus building societies Buiter, Willem Bundesbank Burns, Arthur Bush, George W.


pages: 354 words: 105,322

The Road to Ruin: The Global Elites' Secret Plan for the Next Financial Crisis by James Rickards

"Robert Solow", Affordable Care Act / Obamacare, Albert Einstein, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Bayesian statistics, Ben Bernanke: helicopter money, Benoit Mandelbrot, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bitcoin, Black Swan, blockchain, Bonfire of the Vanities, Bretton Woods, British Empire, business cycle, butterfly effect, buy and hold, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, cellular automata, cognitive bias, cognitive dissonance, complexity theory, Corn Laws, corporate governance, creative destruction, Credit Default Swap, cuban missile crisis, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, debt deflation, Deng Xiaoping, disintermediation, distributed ledger, diversification, diversified portfolio, Edward Lorenz: Chaos theory, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, fiat currency, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, Fractional reserve banking, G4S, George Akerlof, global reserve currency, high net worth, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Isaac Newton, jitney, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, mutually assured destruction, Myron Scholes, Naomi Klein, nuclear winter, obamacare, offshore financial centre, Paul Samuelson, Peace of Westphalia, Pierre-Simon Laplace, plutocrats, Plutocrats, prediction markets, price anchoring, price stability, quantitative easing, RAND corporation, random walk, reserve currency, RFID, risk-adjusted returns, Ronald Reagan, Silicon Valley, sovereign wealth fund, special drawing rights, stocks for the long run, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transfer pricing, value at risk, Washington Consensus, Westphalian system

The devaluation eased financial conditions in the United Kingdom and shifted pressure to the United States, which now had the strongest currency in the world. The United States became a magnet for global deflation. In December 1930, the Bank of United States (a private bank despite its official sounding name), which catered to immigrants and small savers, suffered a bank run and closed its doors. The bank may have been solvent. Prejudice against Jewish and immigrant customers of the bank played a role in the refusal of the large New York Clearing House banks to rescue it. The clearinghouse believed the damage could be contained to the Bank of United States. They were wrong. Bank runs spread like an out-of-control prairie fire. Parts of the United States literally ran out of money. Communities resorted to barter and use of “wooden nickels” to buy food. More than nine thousand U.S. banks failed during the Great Depression.

Yet the global depression began even earlier in the United Kingdom, which experienced depressed conditions through the late 1920s. Germany entered a downturn in 1927. In the United States, stocks and industrial output plunged and unemployment soared beginning in 1929. The most acute phase of the depression, including a global banking panic, was concentrated in the years 1931–33. The European bank panic started in Austria with the failure of Creditanstalt on May 11, 1931. This led quickly to bank runs throughout Europe and the evaporation of commercial credit in London in a dynamic similar to the Panic of 1914. City bankers informed the Bank of England and the U.K. Treasury they would be insolvent in a matter of days if a rescue was not organized by the government. Unlike 1914 when gold convertibility was nominally maintained, this time the U.K. Treasury broke with the gold standard and devalued sterling.


pages: 767 words: 208,933

Liberalism at Large: The World According to the Economist by Alex Zevin

activist fund / activist shareholder / activist investor, affirmative action, anti-communist, Asian financial crisis, bank run, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business climate, business cycle, capital controls, centre right, Chelsea Manning, collective bargaining, Columbine, Corn Laws, corporate governance, corporate social responsibility, creative destruction, credit crunch, David Ricardo: comparative advantage, debt deflation, desegregation, disruptive innovation, Donald Trump, Edward Snowden, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Francis Fukuyama: the end of history, full employment, Gini coefficient, global supply chain, hiring and firing, imperial preference, income inequality, interest rate derivative, invisible hand, John von Neumann, Joseph Schumpeter, Julian Assange, Khartoum Gordon, land reform, liberal capitalism, liberal world order, light touch regulation, Long Term Capital Management, market bubble, Martin Wolf, means of production, Mikhail Gorbachev, Monroe Doctrine, Mont Pelerin Society, moral hazard, Naomi Klein, new economy, New Journalism, Norman Macrae, Northern Rock, Occupy movement, Philip Mirowski, plutocrats, Plutocrats, price stability, quantitative easing, race to the bottom, railway mania, rent control, rent-seeking, road to serfdom, Ronald Reagan, Rosa Parks, Snapchat, Socratic dialogue, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, trade liberalization, trade route, unbanked and underbanked, underbanked, unorthodox policies, upwardly mobile, War on Poverty, WikiLeaks, Winter of Discontent, Yom Kippur War, young professional

‘Such a Bill would rank before a Bill of Barings.’49 The Economist was the source of this authority as well as the most important outlet for his views on bringing stability to the financial system – which by all accounts needed more of it: crises were frequent, either beginning in the City of London or passing through it infinitely magnified, as the spoke around which international finance now turned. At home, the panic of 1866 was among the most spectacular, dominating Economist coverage of the money market long afterwards. In that year one of the City’s great wholesale banking houses, Overend, Gurney & Co., failed soon after it had raised large sums by incorporating as a company with limited liability. After the stock market crashed, a bank run ensued. For Bagehot, the episode demonstrated beyond a doubt that the Bank of England, which at first refused to intervene, was unlike all other banks and discount houses, and Bagehot told Gladstone as much during the crisis, over breakfast on 31 May.50 Bagehot also developed this argument in countless Economist leaders, distilled into a standalone book in 1873, Lombard Street. Since it was backed by government and held the nation’s reserves, the Bank of England had an important duty.

Popular opinion not only grasped how important it was to secure the route to India: ‘No anxiety is shown to reduce the numbers of the Army; strong measures, like the dispatch of a fleet to Smyrna, to secure the surrender of Thessaly to the Greeks, are not resisted; and in recent Egyptian difficulties the country has been, on the whole, in favour of high-handed action.’91 Ireland was the pivot on which both sides of this New Radical realignment – social reform at home, imperial unity abroad – hinged: it was thus significant for both the Economist and for liberalism that Asquith grew so exasperated with the place, backing a wave of repression that set the tone at the paper long after he departed. The Land League, which began to urge Irishmen on to economic disobedience in 1880, calling for rent strikes, boycotts and bank runs, was the object of his special hatred. To eradicate these ‘terrorists’ posing as ‘public benefactors’, responsible for all kinds of ‘agrarian outrages’, no measures were too harsh: indefinite suspension of habeas corpus and jury trials, curfews, round-the-clock police and army patrols, deportations, collective punishment. ‘Nor do we feel much sympathy with the rather pedantic constitutionalism’ of those Liberals who objected to the results: about six hundred Irishmen in jail without trial by 1882, including Charles Parnell, leader of the Irish Home Rulers in parliament.92 Asquith accepted that ‘pacifying’ Ireland depended on settling the land question by creating more ‘peasant proprietors’.

Liberty, humanity, justice, the mitigation of suffering, fostering civilization – all these might justify a call to arms; a ‘sordid squabble, a scramble for concessions and commercial monopolies’ on behalf of France did not.85 The Economist saw another way out of the bitter rivalry between France and Germany, which linked its attack on the two imperialisms, protectionist and free trade. Given the financial panic that gripped Berlin that summer, attributed to French bank withdrawals – a stock market crash, bank runs, a drain of gold abroad – all but forcing the Kaiser to back down in North Africa,86 it was a remarkable suggestion: categorically rejecting the idea that Paris was intentionally turning a ‘financial screw’ on its German neighbour, the paper argued for more French capital to cross the Rhine.87 Throw open the Paris Bourse to German industrial listings, spinning ties of mutual interest not unlike those the City wove with the British Empire.88 As tensions over Agadir eased – France ceding patches of West Africa for effective control in Morocco – Hirst was emboldened, sensing radicals had drawn a line in the sand.


pages: 584 words: 187,436

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, business cycle, buy and hold, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, John Meriwether, Kenneth Rogoff, Kickstarter, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, money market fund, moral hazard, Myron Scholes, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, Paul Samuelson, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Mercer, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, technology bubble, The Great Moderation, The Myth of the Rational Market, the new new thing, too big to fail, transaction costs

He proceeded on his way to the Post House restaurant, just off Madison Avenue, where he dined on steaks with Bernstein and his five Kynikos partners. If Chanos had resented Schwartz’s suggestion when he first heard it, his mood morphed into unrestrained outrage over the next day or so. At six-thirty on Friday morning, when Squawk Box was on the air, word began to spread that the Fed was brokering a rescue for Bear Stearns; the closing of its hedge funds’ margin accounts had been followed by a collapse of confidence and a classic bank run. Schwartz had known the previous evening that his bank was going down, and yet he had tried to inveigle Chanos onto television anyway. “That fucker was going to throw me under the bus,” Chanos recalled later.2 Chanos’s exchange with Schwartz captured the transformed relationship between banks and hedge funds. Back in 1994, Bear Stearns had sunk the wayward hedge fund Askin Capital, forcing it into default and seizing a good portion of its assets.

THE FAILURE OF LEHMAN BROTHERS SPELLED THE END of the modern investment-bank model. Lehman and its rivals had borrowed billions in the short-term money markets, then used the money to buy assets that were hard to sell in a hurry. When the crisis hit, short-term lending dried up instantly; everyone could see that the investment banks might face a crunch, and of course the fear was self-fulfilling. To stave off this sort of bank run, commercial banks have government insurance to reassure depositors and access to emergency lending from the Federal Reserve. But investment banks have no such safety net. Believing that they were somehow invincible, they had behaved as though they did have one. The next domino to fall was Merrill Lynch, the investment bank famous for its “thundering herd” of nearly seventeen thousand stockbrokers.

One of Wall Street’s oldest names was collapsing into the arms of a Main Street commercial bank. As one newspaper wrote, it was as if Wal-Mart were buying Tiffany’s. Now that Bear, Lehman, and Merrill were gone, the two remaining investment banks, Morgan Stanley and Goldman Sachs, came under pressure. All of Wall Street knew that their reliance on short-term funding, coupled with extremely high leverage, made them vulnerable to a bank run; and the Morgan and Goldman stock prices began to show up permanently at the top of the CNBC screen, in what traders called the “death watch.”25 The trouble at the giant insurer AIG only made things worse. By writing credit default swaps, AIG had sold protection against the danger that all manner of bonds might go into default—it was the kind of crazy risk taking you got when you located an ambitious trading operation inside the bosom of a well-capitalized firm, imbuing the traders with a heady sense of invulnerability.


pages: 733 words: 179,391

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

"Robert Solow", Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, Sam Peltzman, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, survivorship bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

They’re critical for resolving the apparent contradiction between the academic perspective of rational markets and the behavioral evidence to the contrary. Rather than accepting one view and rejecting the other, it’s possible to reconcile these two opposing perspectives within a single consistent adaptive framework. We’ll need to know something about how the brain works, how we make decisions, and crucially, how human behavior evolves and adapts, before we can understand bubbles, bank runs, and retirement planning. Each of the disciplines we’ll draw on is a blind monk, unable to provide us with a complete theory, but when taken as a whole, we’ll see the elephant in sharp focus. DON’T TRY THIS AT HOME Many of us have felt fear individually when faced with the power of financial markets, but 2008 was the year the global financial crisis gave the entire world a taste of the finance of fear.

When a bank supervisor first identifies a troubled bank—for example, one that invested its deposits in bad loans that have defaulted—she must decide whether to require the bank to raise additional capital, or to wait and see whether the bank’s assets will rebound. Requiring a bank to raise capital is costly to a bank supervisor. The bank’s response will invariably be negative, and there’s always the risk that this action may cause a loss of confidence among the bank’s customers, possibly triggering a bank run, which is exactly what the additional capital is supposed to help avoid. Even worse, the regulatory action may seem unwarranted after the fact, causing a loss of confidence in the regulator’s competence and bringing down political wrath on the regulator’s agency. Here we have all the ingredients for a classic case of loss aversion: a sure loss to the regulator if she takes action, but a riskier alternative with the possibility of redemption, if only she waits.

Sometimes the crowd is in Greece; sometimes it’s in Argentina. In older black-and-white photos, the crowd might be in Germany or the United States. The crowd might be orderly, assembling itself into neat lines or queues. At other times, however, the crowd will be visibly unsettled or on the knife-edge of violence, and the next series of images will be of riots, burning ATMs, and looted banks. Economists call this form of behavior a bank run, and when many banks are involved, we call it a banking panic. However, if an alien biologist with no experience of Homo sapiens were to see this behavior, s/he/it would be hard pressed to distinguish the crowd of humans from a flock of geese or a herd of gazelle or springbok. Qualitatively, they’re engaging in the same behavior. Both are adaptations to environmental pressures, products of natural selection.


pages: 267 words: 74,296

Unhappy Union: How the Euro Crisis - and Europe - Can Be Fixed by John Peet, Anton La Guardia, The Economist

bank run, banking crisis, Berlin Wall, Bretton Woods, business cycle, capital controls, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, credit crunch, Credit Default Swap, debt deflation, Doha Development Round, eurozone crisis, Fall of the Berlin Wall, fixed income, Flash crash, illegal immigration, labour market flexibility, labour mobility, light touch regulation, market fundamentalism, moral hazard, Northern Rock, oil shock, open economy, pension reform, price stability, quantitative easing, special drawing rights, supply-chain management, The Great Moderation, too big to fail, transaction costs, éminence grise

The deal was sealed with another layer of the favourite Franco-German mix: Sarkozy secured a commitment to hold twice-yearly euro-zone-only summits with the option, in future, of having a separate president; Merkel obtained support for yet another revision of the treaty aimed vaguely at “strengthening economic convergence within the euro area, improving fiscal discipline and deepening economic union”. Yet within days the markets were struck by another bombshell: the Greek prime minister announced on October 31st that he would hold a referendum to approve the terms of the new rescue programme. Markets tumbled. The ECB worried that bank runs would start in Greece. After two years of crushing austerity, nobody could be expected to vote for more of it. Greek bond yields shot up, pulling everyone else along (see Figure 5.1). Italian bonds again pushed past the 6% mark. The euro zone was close to breaking. FIG 5.1 From crisis to crisis Ten-year bond yields, 2010–2012, % Source: Thomson Reuters Caned in Cannes The system of peer-pressure, shy at first and then ever more insistent as the crisis worsened, reached its logical and brutal climax at the G20 summit hosted by Sarkozy in Cannes on November 3rd–4th 2011.

Changing currency is different from leaving a fixed peg. Whether done by returning to national money, or by creating a Germanic northern euro and a Latin southern one, redenomination would mean that currencies, assets and liabilities would all be repriced abruptly. Some companies, in both creditor and debtor countries, would go bust. Some countries that devalued would be crushed by their euro-denominated debt and default. And there could be bank runs as depositors in southern countries rushed to move their savings to northern ones. The dislocation would be most acute for the deficit countries. If the euro has to be split, it would probably be least disruptive if Germany were to leave, either alone or with a group of northern neighbours, allowing the rest to devalue. But Germany would not avoid economic pain, and a euro without the EU’s largest economy would make little sense.


pages: 700 words: 201,953

The Social Life of Money by Nigel Dodd

accounting loophole / creative accounting, bank run, banking crisis, banks create money, Bernie Madoff, bitcoin, blockchain, borderless world, Bretton Woods, BRICs, business cycle, capital controls, cashless society, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computer age, conceptual framework, credit crunch, cross-subsidies, David Graeber, debt deflation, dematerialisation, disintermediation, eurozone crisis, fiat currency, financial exclusion, financial innovation, Financial Instability Hypothesis, financial repression, floating exchange rates, Fractional reserve banking, German hyperinflation, Goldman Sachs: Vampire Squid, Hyman Minsky, illegal immigration, informal economy, interest rate swap, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, Kickstarter, Kula ring, laissez-faire capitalism, land reform, late capitalism, liberal capitalism, liquidity trap, litecoin, London Interbank Offered Rate, M-Pesa, Marshall McLuhan, means of production, mental accounting, microcredit, mobile money, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, negative equity, new economy, Nixon shock, Occupy movement, offshore financial centre, paradox of thrift, payday loans, Peace of Westphalia, peer-to-peer, peer-to-peer lending, Ponzi scheme, post scarcity, postnationalism / post nation state, predatory finance, price mechanism, price stability, quantitative easing, quantitative trading / quantitative finance, remote working, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Satoshi Nakamoto, Scientific racism, seigniorage, Skype, Slavoj Žižek, South Sea Bubble, sovereign wealth fund, special drawing rights, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, Veblen good, Wave and Pay, Westphalian system, WikiLeaks, Wolfgang Streeck, yield curve, zero-coupon bond

They are exchangeable with non-Cypriot euros at a rate of one to one only up to a limit. They are, in this sense, the special purpose money of the Eurozone. Similar issues have arisen elsewhere in Euroland during this crisis. In Greece, a “slow motion bank run” has been underway since the country’s sovereign debt crisis blew up in late 2011. Here, the onus is on moving funds out of the Greek banking system and into safe haven elsewhere in the Eurozone. At its height, Greek banks were reporting €30 million of outflow of funds into other Eurozone member states. This was not a conventional bank run, fueled by fear of bank failure, but a run caused by prevailing concerns about exchange rate risk, and more specifically, about the prospect of an instantaneous devaluation of Greek deposits should the country exit the Eurozone altogether.47 Here too, then, not all euros were equal: not because they could not move but because of an overwhelming sense that they had to.

While wealthier Greeks were investing heavily in London real estate, others were hoarding cash in more mundane domestic spaces because of what might happen to their bank accounts should Greece leave the Eurozone and launch its own independent currency. Fearful that their savings would be decimated overnight, Greeks were reversing the conventional wisdom that a bank is the most secure place to keep your money. What began as a crisis in the U.S. subprime mortgage market in 2007 was now manifesting itself as a slow-motion bank run. This problem was not confined to Greece but was happening throughout the Eurozone amid widespread doubt about the future of a project that had been launched with such optimism a little more than a decade before. Since the collapse of Lehman Brothers in September 2008, the world’s major central banks have been plowing vast quantities of money into the banking system. The U.S. Federal Reserve has made commitments totaling some $29 trillion, lending $7 trillion to banks during the course of one single fraught week.

Should a eurozone member ultimately find itself unable to consolidate its budgets or restore its competitiveness, this country should, as a last resort, exit the monetary union while being able to remain a member of the EU” (Schäuble 2010). 46 After initially proposing a levy or tax on all deposit accounts—9.9 percent for those too big to be covered by the EU-mandated €100,000 deposit guarantee, and 6.75 percent for the smaller depositors—the government reached a compromise whereby only larger depositors would be hit. 47 See Gavyn Davies, “The Anatomy of the Eurozone Bank Run,” Financial Times, May 20, 2012. 48 Following Schmitt, Agamben defines sovereignty in terms of the capacity to suspend the rule of law. He describes the declaration of a state of exception: the ban. It is an idea that “calls into question every theory of the contractual origin of state power and, along with it, every attempt to ground political communities in something like a ‘belonging,’ whether it be founded on popular, national, religious, or other identity” (Agamben 1998: 181). 49 As Agamben describes it, the camp is a piece of land that is “placed outside the normal juridical order, but is nevertheless not simply an external space” (Agamben 2000: 133).


When Free Markets Fail: Saving the Market When It Can't Save Itself (Wiley Corporate F&A) by Scott McCleskey

Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, break the buck, call centre, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, information asymmetry, invisible hand, Isaac Newton, iterative process, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, place-making, Ponzi scheme, prediction markets, risk tolerance, shareholder value, statistical model, The Wealth of Nations by Adam Smith, time value of money, too big to fail, web of trust

In December 2008, nine months after the implosion of Bear Stearns, its former Chairman Ace Greenberg said in an interview that the investment banking model is now dead, that ‘‘that model just doesn’t work because it’s at the mercy of rumors,’’2 and later added that a rumor can put any of these firms at peril. . . . (Even Goldman Sachs and Merrill Lynch) had to convert over the weekend to banks, had to have infusions of capital because they couldn’t withstand the selffulfilling prophecies of the rumors.3 Bank runs and rumors—underlying it all is the crucial, though somewhat slippery, issue of confidence. Once a firm’s ability to raise money and to meet its obligations is questioned, its entire business can seize up almost literally overnight. The downward spiral picks up speed when those responsible for assessing the firm’s value or its ability to pay its debts—research analysts and credit rating agencies, respectively—downgrade the firm’s stock and credit ratings.

See Self-Regulatory Organizations (SROs) Standard & Poor (S&P), 84, 88, 94 structured finance products, 32, 34–36, 73, 84, 88 Stuart, John, xvii–xviii subprime mortgages AAA rating for, 33–34 interest rates, rising, 86 investment bankers, xxi mortgage payments and, 34 pooled risk, 33 ratings, downgrading, xvii–xix, 88, 93 structured investments backed by, 37 as toxic assets, 32–34, 37 systemic risk and market meltdown about, 1 AIG and credit default swaps, 5 Bear Stearns, 2–6, 10, 13–14 borrowed money, short vs. long-term, 2 ‘‘breaking the buck,’’ 8 collateral damage, 6–7 conclusion, 12 economy is about connections, 1 economy is not the sum of its parts, 1 funding, day-to-day, 2–3 government intervention, 9–10, 12 hedge fund redemption, 6 investment practice, legal covenants governing, 4 Lehman repos, 8 leverage, 6 Long Term Capital hedge fund collapse, 11 loss of confidence, 3 margin call, 6 money market fund, 7–9, 11, 92 regulation to focus on firms vs. system as a whole, 12 regulatory reform proposals, 2, 12 repurchase agreement (repo), 3, 6–8, 13 risk of fluctuation in the overnight price of an asset, 3 rumor control and market psychology, 4 rumors, at the mercy of, 4–6 rumors, self-fulfilling nature of, 9 rumors and bank runs, 4 rumors cause a crisis, 4 run on the bank, institutional, 6 SEC regulations restricting what money market fund for investment, 7 six degrees of separation, 11 speculative (junk) bond status, 4 system collapse, why not before?, 10–12 systemic, how a problems goes, 3–10 systemic risk, how it works, 2–9 systemic risk, macro/micro, 2 systemic risk and Bear Stearns, 13–14 system is complex and prone to uncertainty and rumor, 12 toxic assets, difficult-to-price, 6 T TARP.


pages: 310 words: 85,995

The Future of Capitalism: Facing the New Anxieties by Paul Collier

"Robert Solow", accounting loophole / creative accounting, Airbnb, assortative mating, bank run, Berlin Wall, Bernie Sanders, bitcoin, Bob Geldof, bonus culture, business cycle, call centre, central bank independence, centre right, Commodity Super-Cycle, computerized trading, corporate governance, creative destruction, cuban missile crisis, David Brooks, delayed gratification, deskilling, Donald Trump, eurozone crisis, financial deregulation, full employment, George Akerlof, Goldman Sachs: Vampire Squid, greed is good, income inequality, industrial cluster, information asymmetry, intangible asset, Jean Tirole, job satisfaction, Joseph Schumpeter, knowledge economy, late capitalism, loss aversion, Mark Zuckerberg, minimum wage unemployment, moral hazard, negative equity, New Urbanism, Northern Rock, offshore financial centre, out of africa, Peace of Westphalia, principal–agent problem, race to the bottom, rent control, rent-seeking, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, Silicon Valley, Silicon Valley ideology, sovereign wealth fund, The Wealth of Nations by Adam Smith, theory of mind, too big to fail, trade liberalization, urban planning, web of trust, zero-sum game

Local authorities could plan build-to-buy, instead of build-to-rent. But an increase in the supply of housing needs to be gradual: a quantum increase would risk crashing house prices, plunging many young home owners into negative equity. Correspondingly, it makes sense to curb household growth by restoring restrictions on immigration. The credit frenzy unleashed by financial deregulation did not usher in nirvana – it ended in the regulatory disgrace of a bank run. The sight of depositors besieging the branches of Northern Rock was the first such spectacle in Britain for 150 years. As with a house building programme, change will need to be gradual, but its direction is unambiguous: we need to return to ceilings on the ratios of mortgages to income and of mortgages to deposits. It also makes sense to curb buy-to-let. The public benefit from home ownership warrants giving priority to those who want a house-as-home, over those who want a house-as-asset.

Excess asset transactions inflict several social costs beyond their damage to the horizon of firms, discussed in Chapter 4. One is that they widen inequality to no good purpose. The super-smart work for themselves: this is the implication of the bonus system in investment banks, where the stars in effect pay the firm a modest share of their individual profits for the services it provides. Deutsche Bank, the most extreme example of an investment bank run for stars, paid €71 billion in bonuses, dwarfing the €19 billion paid to shareholders.* Power is no longer in the hands of owners of capital, nor even of the managers of their wealth. Pension funds cannot pay the mega-salaries that would be required to recruit stars, and so they are managed by the slightly less smart. Transactions between the two groups generate a gradual transfer from future pensioners to the super-smart.


pages: 468 words: 145,998

On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by Henry M. Paulson

asset-backed security, bank run, banking crisis, break the buck, Bretton Woods, buy and hold, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Doha Development Round, fear of failure, financial innovation, fixed income, housing crisis, income inequality, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, Northern Rock, price discovery process, price mechanism, regulatory arbitrage, Ronald Reagan, Saturday Night Live, short selling, sovereign wealth fund, technology bubble, too big to fail, trade liberalization, young professional

If Bear fell, all these counterparties would be scrambling to collect their loans and collateral. To meet demands for payment, first Bear and then other firms would be forced to sell whatever they could, in any market they could—driving prices down, causing more losses, and triggering more margin and collateral calls. The firms that had already started to pull their money from Bear were simply trying to get out first. That was how bank runs started these days. Investment banks understood that if any questions arose about their ability to pay, creditors would flee at wildfire speed. This is why a bank’s liquidity was so critical. At Goldman we had absolutely obsessed over our liquidity position. We didn’t define it just in the traditional sense as the amount of cash on hand plus unencumbered assets that could be sold quickly. We asked how much money, under the most adverse conditions, could disappear on any given day; if everyone who could legally request their money back did so, how short would we be and could we meet our obligations?

The broader markets fell sharply, too, with the Dow Jones Industrial Average off nearly 300 points. For the day, the dollar hit a then-record low of $1.56 against the euro, while gold soared to a new high of $1,009 an ounce. Despite the backing of JPMorgan and the Fed, doubts remained about Bear’s ability to survive. Its accounts continued to flee, draining its reserves further. We needed to get a deal done by Sunday night, before the Asian markets opened and the bank run went global. That afternoon during a meeting on our housing initiatives, I asked Neel Kashkari if he was going to be around during the weekend, because we might need help on Bear. Neel said: “I have to imagine I’d be more useful to you in New York than sitting next to you in D.C.” I agreed, but before he took off I said, “I am sending you to do something you are totally unqualified to do, but you’re all I’ve got.”

We turned to another key issue—guaranteeing all bank transactional accounts—and picked it up again that afternoon in a conference call with Ben Bernanke, Tim Geithner, Kevin Warsh, Joel Kaplan, and David Nason. This idea was being pushed by Larry Lindsey, a former economic adviser to the president and onetime Fed governor. To pay their bills, companies routinely kept sums of cash in their checking accounts that far exceeded the $100,000 FDIC insurance limit. That left them prone to pulling their money at the first sign of danger and, as with Wachovia, thereby fueling bank runs. We discussed the idea of unlimited guarantees to stabilize these accounts, but we worried that in the midst of a panic, foreign depositors would move their money to the U.S. to take advantage of this new protection, sparking retaliatory actions by other countries and weakening the global financial system. None of us liked Lindsey’s idea, and Tim, in particular, was concerned. He rightly noted that it could lead to all kinds of distortions.


pages: 868 words: 147,152

How Asia Works by Joe Studwell

affirmative action, anti-communist, Asian financial crisis, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collective bargaining, crony capitalism, cross-subsidies, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Deng Xiaoping, failed state, financial deregulation, financial repression, Gini coefficient, glass ceiling, income inequality, income per capita, industrial robot, Joseph Schumpeter, Kenneth Arrow, land reform, land tenure, large denomination, liberal capitalism, market fragmentation, non-tariff barriers, offshore financial centre, oil shock, open economy, passive investing, purchasing power parity, rent control, rent-seeking, Right to Buy, Ronald Coase, South China Sea, The Wealth of Nations by Adam Smith, urban sprawl, Washington Consensus, working-age population

Despite this, as in the contemporary United States, vast numbers of small private banks continued to operate – there were around 2,000 in Japan at the start of the twentieth century – and it was this that allowed for widespread capture of banks by business groups, which went into banking to obtain cheap and reliable supplies of funds for their activities. Captive banks ask fewer questions than independent ones and, when regulation is weak, can lend their owners a great deal of money compared with the investment needed to start or buy a bank. In the United States, havoc broke out among under-regulated small banks in 1907, in a crisis referred to as the Panic. In 1927 Japan faced an even greater number of bank runs and failures. Since the most hopelessly conflicted banks were small ones, the Japanese government passed a new Banking Act that forced banks to merge. However, this simply opened the way for a few huge zaibatsu lenders to dominate. The four biggest ones came to control the majority of credit, pursuing mostly intra-group lending while denying finance to downstream manufacturers outside their groups.

However, this only caused capital flight to accelerate, facilitated by the fact that most capital controls had been lifted in the early 1970s in line with IMF and World Bank advice. Printing money became the only form of finance left. Like Korea, the Philippines was used to an elevated inflation rate because of rediscounting, but price rises accelerated greatly in the mid 1980s. The inflation rate was 50 per cent in 1984 and the currency slid from 7.5 pesos to the dollar in 1980 to 20 in 1986. Following bank runs, bank nationalisations and the closure of large investment houses in 1981, another four banks had to be shut.55 In February 1986, amid large-scale protests, Marcos fled on a US government airplane, at the zenith of a crisis in which the Philippine economy shrank by a quarter.56 The meltdown signalled the end of the Philippines’ association with a particularly perverted form of developmental finance.

Om Liem was very smart and very conservative, but he could not insure against systemic failure. When the Asian crisis spread from Thailand to Indonesia, there was so much panic that BCA, Liem Sioe Liong, the Suhartos and all their monopolies went down with it. The rupiah’s value started to fall at the end of 1997 and it quickly became apparent that the banking system as a whole would be unable to meet its foreign obligations. Bank runs ensued without reference to the particular solvency of individual banks. An extraordinary IDR65 trillion (around USD8 billion)87 was withdrawn from BCA in two weeks as depositor queues snaked around its branches. Liem Sioe Liong was required to put up collateral assets to cover money the central bank lent BCA to pay out its depositors. He handed over assets he said were worth IDR53 trillion, but, when the businesses and land that comprised them were sold, only IDR20 trillion was raised.


pages: 444 words: 151,136

Endless Money: The Moral Hazards of Socialism by William Baker, Addison Wiggin

Andy Kessler, asset allocation, backtesting, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Branko Milanovic, break the buck, Bretton Woods, BRICs, business climate, business cycle, capital asset pricing model, commoditize, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, cuban missile crisis, currency manipulation / currency intervention, debt deflation, Elliott wave, en.wikipedia.org, Fall of the Berlin Wall, feminist movement, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, housing crisis, income inequality, index fund, inflation targeting, Joseph Schumpeter, Kickstarter, laissez-faire capitalism, land reform, liquidity trap, Long Term Capital Management, McMansion, mega-rich, money market fund, moral hazard, mortgage tax deduction, naked short selling, negative equity, offshore financial centre, Ponzi scheme, price stability, pushing on a string, quantitative easing, RAND corporation, rent control, reserve currency, riskless arbitrage, Ronald Reagan, school vouchers, seigniorage, short selling, Silicon Valley, six sigma, statistical arbitrage, statistical model, Steve Jobs, stocks for the long run, The Great Moderation, the scientific method, time value of money, too big to fail, upwardly mobile, War on Poverty, Yogi Berra, young professional

That year saw a stock market rally and active government and Fed intervention, with President Hoover claiming credit for engineering a recovery with a hat tip to the central bank in a speech before the American Bankers Association in October. However, the monetary contraction picked up steam in each year through 1933, ultimately shrinking bank money to $32.2 billion from $46.6 billion four years earlier. Stock market panics, bank runs, and business depressions were much more in the memory of individuals in that era than today. Probably by late 1931 the progression of events began to imbed fear and severely altered behavior, because hopes of merely replaying the comparatively shorter crises since the early 19th century were dashed by the severity of the decline in stock prices through the end of that year, over 74 percent as measured by the Cowles Commission data.

What is even more remarkable about this hypothesis is that policy moderation might have been helpful during the depression in more than one way. An effort by central banks to slightly improve their central bank balance sheets through boosting gold backing by 10 to 30 percent 104 ENDLESS MONEY (i.e., Sweden going from 29% gold backing to 32%) probably brightened the internal investment climate. On one hand it might discourage currency and bank runs, but on the other hand it would not spook capital markets by monopolizing limited state resources through hoarding. Even more interesting is that some countries such as Denmark could take the approach of dialing down what may have been excessive reserves (40% in 1929) to a more manageable ratio (25% in 1934), and be rewarded for it. The tendency of economic researchers to think linearly is a dangerous oversimplification.

Bernanke also added in the possibility that the Fed could become involved in the foreign exchange market, noting that the 40 percent devaluation of the dollar against gold in 1933-34 enforced by Franklin Roosevelt had been effective in ending deflation. Prior to this, the government had outlawed private ownership of gold before resetting its price to $35, in effect taxing private savings and eliminating this refuge from bank runs. Like his statements about the alchemist, this is also nonsensical, because now there is no link to gold. A Penny In the Fuse Box In 2008 Federal Reserve governors more than doubled the central bank’s balance sheet, pumping roughly $1 trillion of credit into member banks and securities markets, and importantly other central banks globally. This action has one parallel historically, when Fed reserves mushroomed from $1.85 billion in February 1932 to $2.51 billion at the end of that year.


pages: 519 words: 148,131

An Empire of Wealth: Rise of American Economy Power 1607-2000 by John Steele Gordon

accounting loophole / creative accounting, bank run, banking crisis, Bretton Woods, British Empire, business cycle, buttonwood tree, California gold rush, clean water, collective bargaining, Corn Laws, corporate governance, cuban missile crisis, disintermediation, double entry bookkeeping, failed state, financial independence, Frederick Winslow Taylor, full employment, global village, imperial preference, informal economy, interchangeable parts, invisible hand, Isaac Newton, Jacquard loom, James Hargreaves, James Watt: steam engine, joint-stock company, joint-stock limited liability company, lone genius, Louis Pasteur, margin call, Marshall McLuhan, means of production, Menlo Park, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, new economy, New Urbanism, postindustrial economy, price mechanism, Ralph Waldo Emerson, RAND corporation, rent control, rent-seeking, reserve currency, rolodex, Ronald Reagan, spinning jenny, The Wealth of Nations by Adam Smith, trade route, transaction costs, transcontinental railway, undersea cable, Yom Kippur War

The Glass-Steagall Act also established the Federal Bank Deposit Insurance Corporation (FDIC), which guaranteed the deposits of banks that joined the system (only banks that were members of the Federal Reserve were required to join) up to $5,000 per account. At a stroke, the bank run, a recurring nightmare in the American economy since the first one in 1809, became a thing of the past. Roosevelt had worried about the “moral hazard” created by a system that relieved bankers of the worry that their depositors’ assets would be wiped out. But he decided that eliminating bank runs was worth it. There has not been a significant American bank run since, but events long after his death would prove that Roosevelt had been right to worry. Glass-Steagall greatly strengthened national banks by permitting them to branch within the states where they were headquartered, if that state permitted branch banking.


pages: 524 words: 155,947

More: The 10,000-Year Rise of the World Economy by Philip Coggan

"Robert Solow", accounting loophole / creative accounting, Ada Lovelace, agricultural Revolution, Airbnb, airline deregulation, Andrei Shleifer, anti-communist, assortative mating, autonomous vehicles, bank run, banking crisis, banks create money, basic income, Berlin Wall, Bob Noyce, Branko Milanovic, Bretton Woods, British Empire, business cycle, call centre, capital controls, carbon footprint, Carmen Reinhart, Celtic Tiger, central bank independence, Charles Lindbergh, clean water, collective bargaining, Columbian Exchange, Columbine, Corn Laws, credit crunch, Credit Default Swap, crony capitalism, currency peg, debt deflation, Deng Xiaoping, discovery of the americas, Donald Trump, Erik Brynjolfsson, European colonialism, eurozone crisis, falling living standards, financial innovation, financial intermediation, floating exchange rates, Fractional reserve banking, Frederick Winslow Taylor, full employment, germ theory of disease, German hyperinflation, gig economy, Gini coefficient, global supply chain, global value chain, Gordon Gekko, greed is good, Haber-Bosch Process, Hans Rosling, Hernando de Soto, hydraulic fracturing, Ignaz Semmelweis: hand washing, income inequality, income per capita, indoor plumbing, industrial robot, inflation targeting, Isaac Newton, James Watt: steam engine, job automation, John Snow's cholera map, joint-stock company, joint-stock limited liability company, Kenneth Arrow, Kula ring, labour market flexibility, land reform, land tenure, Lao Tzu, large denomination, liquidity trap, Long Term Capital Management, Louis Blériot, low cost airline, low skilled workers, lump of labour, M-Pesa, Malcom McLean invented shipping containers, manufacturing employment, Marc Andreessen, Mark Zuckerberg, Martin Wolf, McJob, means of production, Mikhail Gorbachev, mittelstand, moral hazard, Murano, Venice glass, Myron Scholes, Nelson Mandela, Network effects, Northern Rock, oil shale / tar sands, oil shock, Paul Samuelson, popular capitalism, popular electronics, price stability, principal–agent problem, profit maximization, purchasing power parity, quantitative easing, railway mania, Ralph Nader, regulatory arbitrage, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, Second Machine Age, secular stagnation, Silicon Valley, Simon Kuznets, South China Sea, South Sea Bubble, special drawing rights, spice trade, spinning jenny, Steven Pinker, TaskRabbit, Thales and the olive presses, Thales of Miletus, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, trade route, transaction costs, transatlantic slave trade, transcontinental railway, Triangle Shirtwaist Factory, universal basic income, Unsafe at Any Speed, Upton Sinclair, V2 rocket, Veblen good, War on Poverty, Washington Consensus, Watson beat the top human players on Jeopardy!, women in the workforce, Yom Kippur War, zero-sum game

But Roosevelt proclaimed that “We put those payroll contributions there so as to give contributors a legal, moral and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.”80 History has proved him right. Among Roosevelt’s other important reforms were the introduction of deposit insurance, which reduced the temptation for bank runs, the Glass–Steagall Act, which separated commercial from investment banking, and the creation of the Securities Exchange Commission to regulate the finance sector. The idea was to make sure that the riskiest parts of banking, linked to asset trading, did not pull down the conventional business of taking deposits and making loans. Things went wrong in Roosevelt’s second term. Frustrated by its rejection of some of his legislation, he unveiled a plan to pack the Supreme Court with friendly justices, and managed to unite Congress against him.

One obvious example of a shock was the failure of a commercial bank. Fractional reserve banking is prone to crises. Banks have a natural mismatch. They owe money to depositors who can withdraw it at any time, while on the other side of their balance sheets they lend money to individuals and businesses for long periods. If enough depositors want to withdraw their money at once, even a well-run bank will get into trouble. Once a bank run starts, it is hard to stop. If depositors fear a bank will go bust, it makes sense for them to withdraw their money immediately. But this loss of confidence only makes the crisis worse. At this point, the central bank can step in and lend money to the ailing bank to tide it over. It took time for the Bank of England to accept this responsibility. The bank was privately owned until 1947 and its directors were naturally interested, in its early years, in preserving their profits.

The Queen’s question So why didn’t anyone see the crisis coming (as Queen Elizabeth II memorably asked when opening a new building at the London School of Economics)?14 There were several causes. Regulators had been lulled into a false sense of security about the strength of the banking sector in the developed world. The introduction of deposit insurance, in the wake of the Great Depression, seemed to have solved the problem of banking runs. But a moral hazard had been created, in which there was every incentive for bankers to take risk. In the late 19th century, banks in Britain had equity capital equivalent to 15–25% of their assets. By the 1980s, this cushion was just 5%.15 The long period of low interest rates and rising asset prices meant that bankers who were aggressive in their lending practices had been successful. Those bank executives were rewarded with share options, which soared in value.


Not Working by Blanchflower, David G.

active measures, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, bank run, banking crisis, basic income, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, Boris Johnson, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Clapham omnibus, collective bargaining, correlation does not imply causation, credit crunch, declining real wages, deindustrialization, Donald Trump, estate planning, Fall of the Berlin Wall, full employment, George Akerlof, gig economy, Gini coefficient, Growth in a Time of Debt, illegal immigration, income inequality, indoor plumbing, inflation targeting, job satisfaction, John Bercow, Kenneth Rogoff, labor-force participation, liquidationism / Banker’s doctrine / the Treasury view, longitudinal study, low skilled workers, manufacturing employment, Mark Zuckerberg, market clearing, Martin Wolf, mass incarceration, meta analysis, meta-analysis, moral hazard, Nate Silver, negative equity, new economy, Northern Rock, obamacare, oil shock, open borders, Own Your Own Home, p-value, Panamax, pension reform, plutocrats, Plutocrats, post-materialism, price stability, prisoner's dilemma, quantitative easing, rent control, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, selection bias, selective serotonin reuptake inhibitor (SSRI), Silicon Valley, South Sea Bubble, Thorstein Veblen, trade liberalization, universal basic income, University of East Anglia, urban planning, working poor, working-age population, yield curve

It is also apparent from this figure that in August 2008 the UK was already in recession. We didn’t know where we were. We didn’t know where we had been, and we didn’t know where we were going. Same as now. Northern Rock It is not as if there weren’t adequate warnings. During my time on the MPC I watched as thousands of people lined up outside Northern Rock when its website failed. The world was treated to the scenes of a good old bank run. Depositors waiting in line around the country to withdraw their cash. Shin (2009) has noted that the last time that happened was at Overend, Gurney, a London bank that got in trouble in the railway and docks boom of the 1860s. Britain’s deposit-insurance scheme guaranteed fully only the first £2,000 of deposits, and then 90 percent of only the next £33,000. It was sensible to run to the bank to get your money.

As the Treasury Select Committee (TSC) noted, these factors together explained why it did not take many customers seeking to withdraw their funds for queues to extend out the front door and into the street—and into the public consciousness.12 Lines started to form outside branches of Northern Rock on Friday, September 14, as the share price fell 31 percent on the day. Lines continued to form the next day, Saturday. 13 On Monday, September 17, shares opened 31 percent lower. With lines forming again. Alistair Darling intervened, pledging that the government would guarantee all deposits. Northern Rock was eventually nationalized on February 17, 2008. The run was halted. The man in the street was rightly upset at the failure to stop a bank run. The Bank of England knew well before it failed that Northern Rock was in trouble and did nothing about it. It was obvious that if Northern Rock, which depended on access to wholesale money markets and had relatively few depositors, was in trouble so would be others that were dependent on that source of funding. At the top of that list were two building societies, Alliance and Leicester (A&L) and Bradford and Bingley (B&B), but nothing was done by the Bank of England.

Department of Health and Human Services, Centers for Disease Control and Prevention. Shank, S. 1986. “Preferred Hours of Work and Corresponding Earnings.” Monthly Labor Review (November): 40–44. Shiller, R. J. 1997. “Why Do People Dislike Inflation?” In Reducing Inflation: Motivation and Strategy, ed. C. Romer and D. H. Romer, 13–70. Chicago: University of Chicago Press. Shin, H. S. 2009. “Reflections on Northern Rock: The Bank Run That Heralded the Global Financial Crisis.” Journal of Economic Perspectives 23 (1): 101–11. Shiskin, J. 1976. “Employment and Unemployment: The Doughnut and the Hole.” Monthly Labor Review (February): 3–10. Silver, N. 2016. “Education, Not Income, Predicted Who Would Vote for Trump.” http://FiveThirtyeight.com, November 22. Sinha, R. 2009. “Chronic Stress, Drug Use and Vulnerability to Addiction.”


pages: 346 words: 90,371

Rethinking the Economics of Land and Housing by Josh Ryan-Collins, Toby Lloyd, Laurie Macfarlane

"Robert Solow", agricultural Revolution, asset-backed security, balance sheet recession, bank run, banking crisis, barriers to entry, basic income, Bretton Woods, business cycle, Capital in the Twenty-First Century by Thomas Piketty, collective bargaining, Corn Laws, correlation does not imply causation, creative destruction, credit crunch, debt deflation, deindustrialization, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, garden city movement, George Akerlof, ghettoisation, Gini coefficient, Hernando de Soto, housing crisis, Hyman Minsky, income inequality, information asymmetry, knowledge worker, labour market flexibility, labour mobility, land reform, land tenure, land value tax, Landlord’s Game, low skilled workers, market bubble, market clearing, Martin Wolf, means of production, money market fund, mortgage debt, negative equity, Network effects, new economy, New Urbanism, Northern Rock, offshore financial centre, Pareto efficiency, place-making, price stability, profit maximization, quantitative easing, rent control, rent-seeking, Richard Florida, Right to Buy, rising living standards, risk tolerance, Second Machine Age, secular stagnation, shareholder value, the built environment, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, transaction costs, universal basic income, urban planning, urban sprawl, working poor, working-age population

How did a US investment fund specialising in distressed debt come to buy £13 billion worth of nationalised UK mortgages? The story is a remarkable insight into the way in which property and land in the UK has become financialised over the past century. Northern Rock was a bank when, at the height of the financial crisis in February 2008, it was nationalised by the government. Six months earlier, customers were queuing outside its doors to withdraw their cash in the first genuine bank run in the UK since the nineteenth century. But only seven years before Northern Rock was a quite different kind of institution: it was a building society. Over time, many building societies merged, enabling the pooling of liquidity that allowed for larger home building schemes and mortgage financing. In 1965, two North East societies ‒ the Northern Counties Permanent Building Societies (established in 1850) and the Rock Building Societies (established in 1865) – merged and Northern Rock Building Societies was born.

When the US subprime mortgage crisis struck in 2007, this source of money-market funding suddenly dried up. Banks and other providers of liquidity were suddenly no longer prepared to roll over existing wholesale funding as trust between financial institutions collapsed. Because of its heavy money-market exposure, Northern Rock swiftly ran in to a liquidity crisis. By 14 September 2007, queues were forming outside its doors as people sought to withdraw their deposits: a full-on bank run. The bank was swiftly nationalised. The bank’s shareholders lost all of their money. On 1 January 2010 the government split the bank in to two parts: ‘assets’ and ‘banking’. The bad ‘assets’ part, called UK Asset Resolution (Ukar), was made up of the Granite assets as well as the bad loans from another collapsed demutualised building society, the Bradford and Bingley. On 13 November 2015, the Northern Rock mortgages attached to Granite, along with a further £1 billion of Northern Rock loans, was sold to US private equity firm Cerberus Capital Management.


pages: 408 words: 94,311

The Great Depression: A Diary by Benjamin Roth, James Ledbetter, Daniel B. Roth

bank run, banking crisis, business cycle, buy and hold, California gold rush, collective bargaining, currency manipulation / currency intervention, deindustrialization, financial independence, Joseph Schumpeter, market fundamentalism, moral hazard, short selling, statistical model, strikebreaker, union organizing, urban renewal, Works Progress Administration

It’s easy (and instructive) to read this diary and reassure ourselves about how many lessons policy makers learned from the 1930s and how many more economic safety mechanisms are in place. Insurance for the unemployed and guaranteed Social Security income for the elderly and infirm are standard features of the American economy; without them, the impact of current recessions on individuals could easily be as bad as it was during the Depression. On the federal policy level, the government guarantee of bank deposits up to a certain monetary amount makes panicky bank runs less likely and less damaging (though by no means impossible, and of course there are those who argue that such guarantees are harmful; see the above observation about the earth and the sun). And when banks do close, the process is orderly and the impact on the overall financial system minimized. Moreover, decades of experience with monetary policy have given the Federal Reserve—a relatively new institution in Roth’s time—much greater power in steering the economy away from extremes of inflation or unemployment.

Hoover did everything he could but to no avail. The stock market started a decline in October 1929 which continued intermittently until the summer of 1932. At that time good stocks and bonds were selling at 5% and 10% of their 1929 prices. Sheet and Tube had fallen from 175 to 6; Republic from 140 to 2; U.S. Steel from 200 to 20; Western Union sold at 13; Penn RR at 6, etc. Along with this, business was at a stand-still. Bank runs were starting; more than 40,000 people in Youngstown were in bread lines. It was a terrible time. In the meanwhile the voice of the demagog began to be heard throughout the land. Socialism, Communism, more equitable distribution of wealth, new currency and other panaceas became ordinary table talk. 8/12/46 We had very little inflation during the past ten years although it has been widely discussed.


pages: 323 words: 95,188

The Year That Changed the World: The Untold Story Behind the Fall of the Berlin Wall by Michael Meyer

Ayatollah Khomeini, bank run, Berlin Wall, Bonfire of the Vanities, Bretton Woods, BRICs, call centre, Fall of the Berlin Wall, falling living standards, Francis Fukuyama: the end of history, haute couture, mass immigration, Mikhail Gorbachev, mutually assured destruction, Ronald Reagan, Ronald Reagan: Tear down this wall, union organizing

Bush on, 2, 5 fall of, in Bulgaria, 190–191 fall of, in Czechoslovakia, 28, 114, 128, 135–143, 175–190, 205–206 fall of, in GDR, 163–174, 203–205 fall of, in Hungary, 28, 29–39, 41–42, 46, 61, 66–74, 125, 128, 137, 139–140, 143–145, 206–207, 228–231, 236 fall of, in Poland, 28, 35–36, 43–54, 125, 128–133, 137, 139–140, 205 fall of, in Romania, 105–111, 193–201 fall of, throughout Eastern Europe, 41–42, 48, 54, 62, 173–174, 204 oppression in, 36 Reagan and, 13 as term, 224 See also Politburo Constantinescu, Emil, 201 consumer goods, 171–172, 177, 198–199 containment policy, 5, 61 Cooper, Gary, 79 Cornea, Doina, 197–198 counterculture, 21 Cousteau, Jacques, 95 crash of 2008, 218 cult of personality, 110 Cuthbertson, Ian, 228 Czechoslovakia denouement, 205–206 fall of Berlin Wall and, 8 fall of communism in, 28, 114, 128, 135–143, 175–190, 205–206, 233 Prague Spring (1968), 39, 45 refugees from GDR and, 122–123, 135, 141, 148, 152–153 reopening of border with GDR, 158–159 as totalitarian state, 135–143 Velvet Revolution (Prague; 1989), 170, 173, 175–190, 236 Warsaw Pact invasion of (1968), 105–106, 205 See also Prague Dalai Lama, 135, 206 Danner, Mark, 237 Davis, John, 231 DDR Museum (Berlin), 224 death strip (Berlin Wall), 16–18 democracy in Czechoslovakia, 185, 186, 206 in Eastern Europe, 99 in Hungary, 29–32, 41, 55–58, 110, 230–231 in Poland, 58–61, 79–84, 94, 110, 128–133, 225–226, 229–230 Reagan and, 3 U.S., 29, 30, 41 Democratic Forum, 97–99, 99 détente, 5, 61 Deutsche Bank, 73 Diensthier, Jiri, 233 Diepgen, Eberhard, 13 Dietrich, Marlene, 4 Dinescu, Mircea, 197–198 Dissolution (Maier), 163–164, 230–231, 232, 234, 235 Dresden bank runs in, 165 Freedom Train and, 124, 152–153, 154 refugees from GDR and, 117, 124, 135, 152–153, 160 rise of opposition, 152–153, 158 Dubcek, Alexander, 45, 177, 186–187, 226 Duberstein, Kenneth, 11 Dukakis, Michael, 39–40 East Berlin fall of Berlin Wall, 5–9, 65–76, 88–94, 165–173, 203–204 Jubilee of 1989 and, 115, 147–152 May Day (1989), 65–66, 69–70, 228 refugees from GDR and, 119–120, 160–161 rise of opposition, 158 See also Berlin; German Democratic Republic (GDR) Eastern Europe collapse of communism throughout, 41–42, 48, 54, 62, 173–174, 204 revolutions in, 14, 84, 216 Soviet withdrawal from, 12, 38–39, 91 See also names of specific countries East Germany.

Nikolaus Cathedral (Prague), 142 Saint Sebastian, 2 Sakharov, Andrei, 36 samizdat, 32 Schabowski, Gunter collapse of GDR and, 165–173, 204–205, 234–235 fall of Berlin Wall and, 7–10, 65, 69–70, 91, 165–173, 223, 234 Politburo and, 140–141, 148–150, 165–173 refugees from GDR and, 116–117, 120, 123–124, 133–135, 232 repudiation of communism, 204–205 rise of opposition in GDR, 155–156, 158 at Warsaw Pact summit (Bucharest; 1989), 93–94 Schirndling, 160 Schmidt, Helmut, 119 Schultz, George, 61 Schultz, Kurt-Werner, 103 Schumacher, Hans, 236 Schurer, Gerhard, 164, 235 Schwartz, Stephen, 224 Schwerin, bank runs in, 165 Scoblic, Peter, 237–238 Scowcroft, Brent, 9, 40, 60, 61, 95, 224–225, 227, 231, 232 SEATO, 21 secret police, 11–12, 25, 53, 65, 104, 106, 114, 134–136, 140, 151–152, 157, 191, 194–198, 201 Securitate (secret police in Romania), 106, 191, 194–198, 201 September 11, 2001, 2, 215 Shevardnadze, Eduard, 148 fall of Berlin Wall and, 90–91 German reunification proposal and, 125–126 refugees from GDR and, 118 replaces Gromyko, 12 Shultz, George, 75, 227 Siani-Davies, Peter, 236 Sicherman, Harvey, 227 Siegessäule (Berlin), 15 Sieland, Gisela, 19 Skoda, Jan, 185 Skoda autoworks, 185 Sleepwalking through History (Hutchings), 227 Slum Clearance (Havel), 206 Smith, Stephen, 128, 141–142 socialism Gorbachev and, 56 as term, 224 Socialist Unity Party, 26 Society for a Merrier Present (Czechoslovakia), 139 soft power, 13–14 Solidarity (Poland) elections of 1989, 79–84, 128–133, 225–226, 229–230, 233 fall of communism and, 28, 32, 35–36 Jaruzelski embraces, 45–46, 50–54, 205 origins of, 47, 52, 94 in revolution of 1989, 47–54 rise of, 50–54, 58–61 uprising of 1980, 43–46 Somalia, 210 Sopron, Hungary, Pan-European Picnic (1989), 97–104 Soviet Union, former ascent of Gorbachev within, 11–14, 25 Brezhnev Doctrine and, 39, 45, 63 collapse of, 5, 14, 45, 62, 71, 204 fall of Berlin Wall, 5–10, 90–91 fall of communism in Czechoslovakia, 28 fall of communism in Hungary, 28, 29–39, 41–42, 66–74 fall of communism in Poland, 28 flaws of Soviet system, 11–12 Hungarian revolt of 1956, 34–35 Hungary and, 38 impact of Cold War and.


pages: 354 words: 92,470

Grave New World: The End of Globalization, the Return of History by Stephen D. King

9 dash line, Admiral Zheng, air freight, Albert Einstein, Asian financial crisis, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Sanders, bilateral investment treaty, bitcoin, blockchain, Bonfire of the Vanities, borderless world, Bretton Woods, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collateralized debt obligation, colonial rule, corporate governance, credit crunch, currency manipulation / currency intervention, currency peg, David Ricardo: comparative advantage, debt deflation, deindustrialization, Deng Xiaoping, Doha Development Round, Donald Trump, Edward Snowden, eurozone crisis, facts on the ground, failed state, Fall of the Berlin Wall, falling living standards, floating exchange rates, Francis Fukuyama: the end of history, full employment, George Akerlof, global supply chain, global value chain, hydraulic fracturing, Hyman Minsky, imperial preference, income inequality, income per capita, incomplete markets, inflation targeting, information asymmetry, Internet of things, invisible hand, joint-stock company, Kickstarter, Long Term Capital Management, Martin Wolf, mass immigration, Mexican peso crisis / tequila crisis, moral hazard, Nixon shock, offshore financial centre, oil shock, old age dependency ratio, paradox of thrift, Peace of Westphalia, plutocrats, Plutocrats, price stability, profit maximization, quantitative easing, race to the bottom, rent-seeking, reserve currency, reshoring, rising living standards, Ronald Reagan, Scramble for Africa, Second Machine Age, Skype, South China Sea, special drawing rights, technology bubble, The Great Moderation, The Market for Lemons, the market place, The Rise and Fall of American Growth, trade liberalization, trade route, Washington Consensus, WikiLeaks, Yom Kippur War, zero-sum game

More dollars were held in reserve abroad than could be redeemed for American gold. According to the IMF, ‘In 1966, foreign central banks and governments held over 14 billion US dollars. The United States had $13.2 billion in gold reserves, but only $3.2 billion of that was available to cover foreign dollar holdings. The rest was needed to cover domestic holdings.’2 Put another way, the entire financial system was vulnerable to a public sector version of a bank run. If other nations thought there was any risk that their dollar holdings would be devalued, they would sensibly demand that their reserves should immediately be converted into gold. If, however, everyone thought that way, then devaluation would become inevitable. The link between dollars and gold established by Harry Dexter White in the 1940s was ultimately an act of faith: by the mid-1960s, however, faith was in short supply.

Visitors to Washington found notes in their hotel rooms informing them that cheques drawn on out-of-town banks were no longer acceptable. With state after state declaring a bank holiday, something had to be done. The answer came partly in the form of deposit insurance. As an emergency measure in direct response to the March meltdown, Congress agreed to offer insurance protection to each depositor up to a maximum of $2,500 ($44,800 in 2015 US dollars) in the hope that bank runs would be stymied. In July of the following year, the level of protection was raised to $5,000 ($89,000 in 2015 US dollars). The policy worked, to the extent that the financial system was stabilized and confidence returned. It also, however, introduced moral hazard. Thanks to deposit insurance, most depositors no longer had to worry about what their bank was up to: their money was safe, come what may.


pages: 329 words: 95,309

Digital Bank: Strategies for Launching or Becoming a Digital Bank by Chris Skinner

algorithmic trading, AltaVista, Amazon Web Services, Any sufficiently advanced technology is indistinguishable from magic, augmented reality, bank run, Basel III, bitcoin, business cycle, business intelligence, business process, business process outsourcing, buy and hold, call centre, cashless society, clean water, cloud computing, corporate social responsibility, credit crunch, crowdsourcing, cryptocurrency, demand response, disintermediation, don't be evil, en.wikipedia.org, fault tolerance, fiat currency, financial innovation, Google Glasses, high net worth, informal economy, Infrastructure as a Service, Internet of things, Jeff Bezos, Kevin Kelly, Kickstarter, M-Pesa, margin call, mass affluent, MITM: man-in-the-middle, mobile money, Mohammed Bouazizi, new economy, Northern Rock, Occupy movement, Pingit, platform as a service, Ponzi scheme, prediction markets, pre–internet, QR code, quantitative easing, ransomware, reserve currency, RFID, Satoshi Nakamoto, Silicon Valley, smart cities, social intelligence, software as a service, Steve Jobs, strong AI, Stuxnet, trade route, unbanked and underbanked, underbanked, upwardly mobile, We are the 99%, web application, WikiLeaks, Y2K

In particular, the fact that Second Life allowed real commerce to be transacted by converting real US dollars to virtual dollars, meant that everyone started to test commerce in virtual worlds through the service. For example, several banks invested in major projects in Second Life, including ING, Wells Fargo, SAXO Bank and Deutsche Bank. However, several banks also operated in Second Life that were managed by guys in their bedrooms. These included banks such as Ginko Bank, run by a Brazilian chap at home. The trouble Ginko Bank experienced started when internet gambling was forced to close under US Laws. The management of Second Life decided that they also had to close access to gambling in virtual worlds in July 2007 to comply with this policy, which led to a major run on the virtual banks. Until this date, a lot of the commercial transactions taking place in Second Life, where people converted real US dollars to Linden dollars, were for gambling purposes apparently.

It all began when George W Bush introduced a ban on internet gambling, and any firm on US shores who offered online trading would be threatened with lengthy jail sentences. Second Life’s operators were worried that this might affect them, and hence they banned gambling too. What the operators of Second Life did not realise is that gambling was really popular in their virtual world and, as a result of the gambling lockdown, many users wanted to withdraw their funds. So began a small bank run, with one of the largest banks in Second Life at this time being Ginko Bank. Ginko Bank had L$300 million in assets – about US$1.5 million in real money. As the bank saw a mass withdrawal of funds – around L$100 million in a couple of days – the bank’s owner deleted his Second Life account. Yes, you guessed it, Ginko Bank was just a virtual bank being run by a Sao Paolo internet freak, Andre Sanchez, from his bedroom.


Future Files: A Brief History of the Next 50 Years by Richard Watson

Albert Einstein, bank run, banking crisis, battle of ideas, Black Swan, call centre, carbon footprint, cashless society, citizen journalism, commoditize, computer age, computer vision, congestion charging, corporate governance, corporate social responsibility, deglobalization, digital Maoism, disintermediation, epigenetics, failed state, financial innovation, Firefox, food miles, future of work, global pandemic, global supply chain, global village, hive mind, industrial robot, invention of the telegraph, Jaron Lanier, Jeff Bezos, knowledge economy, lateral thinking, linked data, low cost airline, low skilled workers, M-Pesa, mass immigration, Northern Rock, peak oil, pensions crisis, precision agriculture, prediction markets, Ralph Nader, Ray Kurzweil, rent control, RFID, Richard Florida, self-driving car, speech recognition, telepresence, the scientific method, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Turing test, Victor Gruen, white flight, women in the workforce, Zipcar

The serious point here is that life is blurring between the real and the virtual, and financial services are no exception. People are Money and Financial Services 131 already exchanging real money for virtual goods and vice versa, so why not invent new products and services for this market? Several US-based retailers (including a real bank) have opened virtual branches inside virtual games, so why not open a bank-run virtual currency-trading exchange where gamers can exchange their World of Witchcraft EU gold or Second Life Linden dollars for real gold or US dollars? If that’s a bit too weird for you, how about a real credit card that earns the virtual currency of your choice when you buy a pair of real jeans or an iPod? It could work the other way around too: a real card personalized with a picture of your avatar that earns points every time you spend real money on virtual goods (like virtual clothes or real estate for your avatar).

In a fast-paced, globalized world, the love of the new dominates. But in a downturn, security will be paramount and new entrants and foreign banks will be rejected in favor of long-established local names. Except, that is, if the name includes words like “Northern” and “Rock”. I was in Australia in 2007 when the UK’s fifth-largest mortgage lender became the first bank in Britain since 1866 to be the subject of a bank run. There were people queuing down high streets all over the country trying to get their cash out, until the government agreed to use taxpayers’ money to guarantee their savings. It effectively said that it would bail out anyone who invested 140 FUTURE FILES in a major UK financial institution that had forgotten that there should be some balance between borrowing and lending. The problem, of course, was that Northern Rock was too clever by half.


pages: 358 words: 106,729

Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, assortative mating, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, business cycle, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, fixed income, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, longitudinal study, market bubble, Martin Wolf, medical malpractice, microcredit, money market fund, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

However, an intriguing study suggests that bank CEOs in some of the worst-hit banks did not lack for incentives to manage their banks well.8 Richard Fuld at Lehman owned about $1 billion worth of Lehman stock at the end of fiscal year 2006, and James Cayne of Bear Stearns owned $953 million. These CEOs lost tremendous amounts when their firms were brought down by what were effectively modern-day bank runs. Indeed, the study shows that banks in which CEOs owned the most stock typically performed the worst during the crisis. These CEOs had substantial amounts to lose if their bets did not play out well (no matter how rich they otherwise were). Unlike those of some of their traders, their bets were not one-way. One explanation is the CEOs were out of touch. An unflattering portrayal of Fuld has him holed up in his office on the 31st floor of Lehman’s headquarters with little knowledge of what was going on in the rest of the building.9 Indeed, in a tongue-in-cheek op-ed piece in the New York Times, Calvin Trillin argued that Wall Street’s problem was that it had undergone a revolutionary change in the quality of personnel over generations.10 In Trillin’s time in college, only those in the bottom third of their university class used to go on to Wall Street careers, which were boring and only moderately remunerative.

I asked earlier whether the activities of insured banks should be restricted. Perhaps a better question is whether banks should have deposit insurance at all. This may be a strange question to ask at a time when governments all over the world have guaranteed all the debt issued by their banks, not just the small, already insured deposits. But that is precisely the reason for my question. Deposit insurance is not meant to quell panics by preventing bank runs: the government, as we have recently seen, takes care of that. Instead, it merely protects individual banks from market discipline. Put differently, with implicit government guarantees all over the place, should we not strive to remove explicit government guarantees where we can? One reason for insuring deposits was to provide a safe means of savings to households where none existed. Today, this rationale is archaic—a money-market fund invested in Treasury bills can provide that safety.


pages: 338 words: 106,936

The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen Weatherall

Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, beat the dealer, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business cycle, butterfly effect, buy and hold, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, Myron Scholes, new economy, Paul Lévy, Paul Samuelson, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, Vilfredo Pareto, volatility smile

He has just enough money that, at the close of the business day, the bank has $1 left and they can shut the doors for the night without going out of business. They have survived the run, but at the expense of Bailey’s dreams of traveling the world. Bank runs were fairly common during the Depression, and even more common during the nineteenth century. They were associated with financial panics, periods in which the economy seemed especially uncertain and no one was sure which banks would survive. A small piece of news that a particular bank was endangered could practically ensure that the bank would fail. Today, bank runs in the United States are a thing of the past, because in 1934 the U.S. government instituted the Federal Deposit Insurance Corporation (FDIC), which insures all consumer bank deposits. Now there’s no reason to make a run on a bank, even if you think it’s failing: your money is insured by the federal government, no matter what happens.


The Permanent Portfolio by Craig Rowland, J. M. Lawson

Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

Counterparty risk is the notion that the party you give your money to won't be able to give it back when you ask for it. Counterparty risk is hard to manage, in part, because the periods when an investor most needs access to their funds are often the periods when the parties holding the funds are the least able to return them (usually because they need them for their own emergency). Emergencies cause cascading effects. A common counterparty risk is a bank run. This is when a large number of depositors want their money at the same time and the bank doesn't have enough funds on hand. The result could be the bank simply goes out of business and then, hopefully, government insurance takes over. That's counterparty risk. In order to meet the requirement of absolute safety, Permanent Portfolio investors shouldn't have to evaluate the creditworthiness of the party to whom they are entrusting their wealth.

The difference between the interest that the bank pays you on your CD and the interest your neighbor pays on his loan is one of the ways the bank makes its profits. This business model means that at any given time the bank will only have a small amount of its depositors' money available for withdrawal (the rest is loaned out to the bank's customers and is tied up in their car, home, business, etc.). But what happens when too many people try to withdraw their money from the bank at the same time? This situation causes the familiar bank runs. The government has attempted to ease the fear of this sort of event through the Federal Deposit Insurance Corporation (FDIC), which was created in the 1930s and insures all deposits up to a certain amount. Although FDIC deposit insurance has worked to date, the reality is that the FDIC actually has very few assets in relation to its liabilities. That means a wide-scale bank failure could quickly wipe out all of the FDIC's reserves.


pages: 405 words: 109,114

Unfinished Business by Tamim Bayoumi

algorithmic trading, Asian financial crisis, bank run, banking crisis, Basel III, battle of ideas, Ben Bernanke: helicopter money, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business cycle, buy and hold, capital controls, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, currency manipulation / currency intervention, currency peg, Doha Development Round, facts on the ground, Fall of the Berlin Wall, financial deregulation, floating exchange rates, full employment, hiring and firing, housing crisis, inflation targeting, Just-in-time delivery, Kenneth Rogoff, liberal capitalism, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, market bubble, Martin Wolf, moral hazard, oil shale / tar sands, oil shock, price stability, prisoner's dilemma, profit maximization, quantitative easing, race to the bottom, random walk, reserve currency, Robert Shiller, Robert Shiller, Rubik’s Cube, savings glut, technology bubble, The Great Moderation, The Myth of the Rational Market, the payments system, The Wisdom of Crowds, too big to fail, trade liberalization, transaction costs, value at risk

The overall result, however, is similar and since the data does not go back reliably over time I use the simpler definition of debt and equity flows. 5.There is a similar, if less direct, increase in risk for investors who lend in dollars, as a depreciation in the value of the pound increases the cost of dollar repayments for all foreign investors, thereby making all of the loans riskier. 6.Jeanne and Zettelmeyer (2005) provide a survey. See Krugman (1992) on the first generation models and Obstfeld (1996) on the second generation. 7.This is closely related to earlier models of bank runs, in which a run is always a risk unless government insurance gives depositors the assurance that their money is safe. Diamond and Dybvig (1983). 8.Bergsten and Green (2016). 9.IMF (2012b) paragraph 18 and references therein. 10.Garber (1993) contains a more detailed description of the collapse of the Bretton Woods system. 11.Eichengreen (1992). 12.Eichengreen (2008) contains a description of the evolution of capital market regulation over time. 13.Skidelsky (2001). 14.The Bretton Woods system came to maturity in 1960 after the termination of the European Payments Union (EPU), an arrangement that curtailed even current account transactions because of the severe shortages of dollars after the war. 15.Federal Deposit Insurance Corporation (1997b), Cline (1984 and 1995), Cohen (1992) and Dooley (1994) contain descriptions. 16.Quoted in Federal Deposit Insurance Corporation (1997b), pp. 197–8. 17.Ibid., p. 204. 18.Seidman (2000), pp. 127–8. 19.L.

Davis Polk (2015): “Federal Reserve’s Proposed Rule on Total Loss-Absorbing Capacity and Eligible Long-Term Debt”, available at davispolk.com. Dermine (2002): Jean Dermine, “European Banking: Past, Present, and Future”, paper given at The Transformation of the European Financial System, Second ECB Central Banking Conference, Frankfurt am Main, October 24–25, 2002. Diamond and Dybvig (1983): Douglas W. Diamond and Philip H. Dybvig, “Bank Runs, Deposit Insurance, and Liquidity”, Journal of Political Economy, Vol. 91, No. 3 (June 1983), pp. 401–19. Dooley (1994): Michael P. Dooley, “A Retrospective on the Debt Crisis”, NBER Working Paper No. 4963, December 1994. Edwards (1999): Franklin R. Edwards, “Hedge Funds and the Collapse of Long-Term Capital Management”, Journal of Economic Perspectives, Vol. 13, No. 2 (Spring 1999), pp. 189–210.


pages: 385 words: 111,807

A Pelican Introduction Economics: A User's Guide by Ha-Joon Chang

Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, bilateral investment treaty, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collateralized debt obligation, colonial rule, Corn Laws, corporate governance, corporate raider, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, discovery of the americas, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, full employment, George Akerlof, Gini coefficient, global value chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Gunnar Myrdal, Haber-Bosch Process, happiness index / gross national happiness, high net worth, income inequality, income per capita, information asymmetry, intangible asset, interchangeable parts, interest rate swap, inventory management, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, laissez-faire capitalism, land reform, liberation theology, manufacturing employment, Mark Zuckerberg, market clearing, market fundamentalism, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, Nelson Mandela, Northern Rock, obamacare, offshore financial centre, oil shock, open borders, Pareto efficiency, Paul Samuelson, post-industrial society, precariat, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, shareholder value, Silicon Valley, Simon Kuznets, sovereign wealth fund, spinning jenny, structural adjustment programs, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade liberalization, transaction costs, transfer pricing, trickle-down economics, Vilfredo Pareto, Washington Consensus, working-age population, World Values Survey

She knows that her bank actually does not have the cash to pay all her fellow depositors, should a sufficient number of them want to withdraw their deposits in cash at the same time. Even though the belief may be totally unfounded – as was the case with the Fidelity Fiduciary Bank – it will become a ‘self-fulfilling prophecy’ if enough account holders think and act in this way. This situation is known as a bank run. We have seen examples of it in the wake of the 2008 global financial crisis. Customers queued up in front of Northern Rock bank branches in the UK, while online depositors in the UK and the Netherlands clogged up the website of Icesave, the internet arm of the collapsing Icelandic bank Landsbanki. Banking is a confidence trick (of a sort), but a socially useful one (if managed well) So, is banking a confidence trick?

Under this insurance scheme, the government commits itself to compensate all depositors up to a certain amount (for example, €100,000 in the Eurozone countries at the moment), if their banks are unable to pay their money back. With this guarantee, savers do not have to panic and withdraw their deposits at the slightest fall in confidence in their banks. This significantly reduces the chance of a bank run. Another way to manage confidence in the banking system is to restrict the ability of the banks to take risk. This is known as prudential regulation. One important measure of prudential regulation is the ‘capital adequacy ratio’. This limits the amount that a bank can lend (and thus the liabilities it can create in the form of deposits) to a certain multiple of its equity capital (that is, the money provided by the bank’s owners, or shareholders).


pages: 378 words: 110,518

Postcapitalism: A Guide to Our Future by Paul Mason

Alfred Russel Wallace, bank run, banking crisis, banks create money, Basel III, basic income, Bernie Madoff, Bill Gates: Altair 8800, bitcoin, Branko Milanovic, Bretton Woods, BRICs, British Empire, business cycle, business process, butterfly effect, call centre, capital controls, Cesare Marchetti: Marchetti’s constant, Claude Shannon: information theory, collaborative economy, collective bargaining, Corn Laws, corporate social responsibility, creative destruction, credit crunch, currency manipulation / currency intervention, currency peg, David Graeber, deglobalization, deindustrialization, deskilling, discovery of the americas, Downton Abbey, drone strike, en.wikipedia.org, energy security, eurozone crisis, factory automation, financial repression, Firefox, Fractional reserve banking, Frederick Winslow Taylor, full employment, future of work, game design, income inequality, inflation targeting, informal economy, information asymmetry, intangible asset, Intergovernmental Panel on Climate Change (IPCC), Internet of things, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, Kevin Kelly, Kickstarter, knowledge economy, knowledge worker, late capitalism, low skilled workers, market clearing, means of production, Metcalfe's law, microservices, money: store of value / unit of account / medium of exchange, mortgage debt, Network effects, new economy, Norbert Wiener, Occupy movement, oil shale / tar sands, oil shock, Paul Samuelson, payday loans, Pearl River Delta, post-industrial society, precariat, price mechanism, profit motive, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, RFID, Richard Stallman, Robert Gordon, Robert Metcalfe, secular stagnation, sharing economy, Stewart Brand, structural adjustment programs, supply-chain management, The Future of Employment, the scientific method, The Wealth of Nations by Adam Smith, Transnistria, union organizing, universal basic income, urban decay, urban planning, Vilfredo Pareto, wages for housework, WikiLeaks, women in the workforce

Today there is no Geneva Convention when it comes to the fight between elites and the people they govern: the robo-cop has become the first line of defence against peaceful protest. Tasers, sound lasers and CS gas, combined with intrusive surveillance, infiltration and disinformation, have become standard in the playbook of law enforcement. And the central banks, whose operations most people have no clue about, are prepared to sabotage democracy by triggering bank runs where anti-neoliberal movements threaten to win – as they did with Cyprus in 2013, then Scotland and now Greece. The elite and their supporters are lined up to defend the same core principles: high finance, low wages, secrecy, militarism, intellectual property and energy based on carbon. The bad news is that they control nearly every government in the world. The good news is that in most countries they enjoy very little consent or popularity among ordinary people.

Next to the pawnbrokers you’ll probably find that other gold mine of the poverty-stricken town: the employment agency. Look in the window and you’ll see ads for jobs at the minimum wage – but which require more than minimum skill. Press operatives, carers on night shift, distribution centre workers: jobs that used to pay decent wages now pay as little as legally possible. Somewhere else, out of the limelight, you will come across people picking up the pieces: food banks run by churches and charities; Citizens’ Advice Bureaux whose main business has become advising those swamped by debt. Just one generation earlier these streets were home to thriving real businesses. I remember the main street of my home town, Leigh, in northwest England, in the 1970s, thronged on Saturday mornings with prosperous working-class families. There was full employment, high wages and high productivity.


pages: 408 words: 108,985

Rewriting the Rules of the European Economy: An Agenda for Growth and Shared Prosperity by Joseph E. Stiglitz

Airbnb, balance sheet recession, bank run, banking crisis, barriers to entry, Basel III, basic income, Berlin Wall, bilateral investment treaty, business cycle, business process, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, corporate governance, corporate raider, corporate social responsibility, creative destruction, credit crunch, deindustrialization, discovery of DNA, diversified portfolio, Donald Trump, eurozone crisis, Fall of the Berlin Wall, financial intermediation, Francis Fukuyama: the end of history, full employment, gender pay gap, George Akerlof, gig economy, Gini coefficient, hiring and firing, housing crisis, Hyman Minsky, income inequality, inflation targeting, informal economy, information asymmetry, intangible asset, investor state dispute settlement, invisible hand, Isaac Newton, labor-force participation, liberal capitalism, low skilled workers, market fundamentalism, mini-job, moral hazard, non-tariff barriers, offshore financial centre, open economy, patent troll, pension reform, price mechanism, price stability, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, shareholder value, Silicon Valley, sovereign wealth fund, TaskRabbit, too big to fail, trade liberalization, transaction costs, transfer pricing, trickle-down economics, tulip mania, universal basic income, unorthodox policies, zero-sum game

While there has been an agreement to create a banking union, and some steps have been taken, even today a common deposit insurance system appears to be a distant hope. Reforming Europe’s financial system has to go hand in hand with reforming the dysfunctional macro-institutional architecture of the euro, as we discussed in Chapter 2. An unreformed shadow banking system both increases the risk of a crisis and undermines the ability of the ECB to respond. A lender of last resort that can address a bank run caused by retail deposit withdrawals faces a far greater challenge when market liquidity evaporates and falling securities prices prompt a run on wholesale funding. In this latter case, the scale of required intervention is greater and the mechanisms for preventing systemic collapse are less straightforward. In the 2008 crisis, central banks bought up securities to keep markets stable, a more intrusive and massive intervention in markets than had traditionally been part of their work.

In fact, excessive zeal in shutting banks down may simply lead to further credit contraction that could exacerbate the economic downturn. Such forbearance may prove essential, especially in the absence of the maneuverability provided by flexible exchange rates and differential interest rates. Common resolution When all else fails, Europe will need a mechanism for the resolution of troubled banks that winds them down without triggering a systemic crisis. When a single, isolated bank runs into a problem, resolution is straightforward: one wants to protect depositors, promote the continued flow of credit, and minimize the cost to taxpayers. The difficulty arises in a crisis, when many banks are in trouble at the same time. The United States created a new process for complex banks (Orderly Liquidation Authority) and a requirement that firms plan for their own demise (living wills) to supplement the previous system in which the Federal Deposit Insurance Corporation wound down banks while protecting depositors.


London Under by Peter Ackroyd

bank run, dark matter, The Spirit Level

As the price of gold rises ever higher many London banks are building larger and deeper vaults to accommodate the precious metal; they are great caverns of treasure. It is estimated that 250 million ounces of gold are concealed beneath the ground. But no London cellar is more wonderful than the vaults of the Bank of England. They contain the second biggest hoard of gold bullion on the planet. A network of tunnels, radiating out from the bank, runs beneath the City streets. Several thousand bars of 24-carat gold, each one weighing 28 pounds, are stored within them. They may be said to light up the bowels of the earth. You would not know, on walking along High Holborn or Whitehall, that there is a secret world beneath your feet. There is no echo, no sign or token, of corridors and chambers below the surface. You would pass its gateways without giving them a second glance.


pages: 113 words: 37,885

Why Wall Street Matters by William D. Cohan

Apple II, asset-backed security, bank run, Bernie Sanders, Blythe Masters, bonus culture, break the buck, buttonwood tree, corporate governance, corporate raider, creative destruction, Credit Default Swap, Donald Trump, Exxon Valdez, financial innovation, financial repression, Fractional reserve banking, Gordon Gekko, greed is good, income inequality, Joseph Schumpeter, London Interbank Offered Rate, margin call, money market fund, moral hazard, Potemkin village, quantitative easing, secular stagnation, Snapchat, South Sea Bubble, Steve Jobs, Steve Wozniak, too big to fail, WikiLeaks

The short-term loans ran away, he’s right to point out, leaving Bear Stearns, Merrill Lynch, Lehman Brothers, and Morgan Stanley, among others, without enough liquidity to operate their businesses. Chaos ensued. “As has been frequently observed, the recent financial crisis began, like most banking crises, with a run on short-term liabilities by investors who had come to doubt the value of the assets they were funding through various kinds of financial intermediaries,” he said in his July 2016 speech. He noted correctly that unlike the bank runs that typified the 1930s, when small depositors lined up to get their money out, in 2008 it was the institutions that ran for the exits without having to line up at all. They got out simply by—literally—pushing a button on their computers. What happened next, Tarullo explained, was that the Wall Street banks, “lacking enough liquidity to repay all the counterparties who declined to roll over their investments,” were forced “into fire sales that further depressed asset prices, thereby reducing the values of assets held by many other intermediaries, raising margin calls, and leading to still more asset sales.”


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bernie Madoff, break the buck, centre right, collapse of Lehman Brothers, collateralized debt obligation, commoditize, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, light touch regulation, Long Term Capital Management, low earth orbit, mega-rich, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, plutocrats, Plutocrats, Ponzi scheme, price anchoring, price stability, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, too big to fail, trickle-down economics, value at risk, yield curve

One of the really astonishing aspects of these stories is how little those involved seem to have learned. The chairman of Northern Rock, Matt Ridley, was interrogated by British parliamentarians in the wake of the crisis‌—‌a crisis that had prompted the first bank run in Britain for 150 years. Instead of sounding apologetic or humble about his failures, Ridley sounded plaintive. He complained: ‘The idea that all markets would close simultaneously was unforeseen by any major authority. We were hit by an unexpected and unpredictable concatenation of events.’14 Well, duh! Of course you don’t expect the unexpected. That’s why you take precautions and prudently manage your risks accordingly. The fact that Britain hadn’t experienced a bank run for 150 years suggests that those precautions were hardly unknown to Ridley’s predecessors. But in the era of the Ponzi scheme, why burden yourself with common sense, when you can just press the pedal to the metal and see how far you can travel before the engine blows?


pages: 403 words: 119,206

Toward Rational Exuberance: The Evolution of the Modern Stock Market by B. Mark Smith

bank run, banking crisis, business climate, business cycle, buy and hold, capital asset pricing model, compound rate of return, computerized trading, credit crunch, cuban missile crisis, discounted cash flows, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, full employment, income inequality, index arbitrage, index fund, joint-stock company, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market clearing, merger arbitrage, money market fund, Myron Scholes, Paul Samuelson, price stability, random walk, Richard Thaler, risk tolerance, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, stocks for the long run, the market place, transaction costs

Shortly thereafter, the Banking Act of 1933, to become better known as the Glass-Steagall Act, gave the Federal Reserve more control over member banks’ speculative activities and drew a distinct line between the activities of commercial and investment banks by requiring that commercial banks divest themselves of investment affiliates. The legislation also created the Federal Deposit Insurance Corporation to insure bank deposits, an extremely important innovation that would virtually eliminate bank runs in the future. Neither the Securities Act of 1933 nor Glass-Steagall met strong resistance from the Wall Street community, which recognized that some form of new regulation was inevitable and found these first pieces of New Deal legislation to be at least tolerable. Overt regulation of the market, however, was a different matter. It was commonly assumed that abusive behavior by stock market operators had at least in part caused the crash, and thus the Depression.

At the time of the 1963 “salad oil” debacle, the New York Stock Exchange had intervened to protect customers of Ira Haupt & Company, establishing an important precedent that led to the formation of the Securities Investor Protection Corporation, which removed a significant element of risk (brokerage firm failures) that had in the past led to stock market panics. The 1930s reform legislation that provided federal deposit insurance for banks had already greatly reduced the risk of bank runs, another former cause of panics. Now, in 1980, the Fed’s decision to effectively bail out the Hunts indicated a proactive willingness to intervene in the markets to forestall crises that, if left unchecked, could wreak havoc on the financial system and the stock market. This is an extremely important point. The risk of external shocks to the stock market had been sharply curtailed. While there was (and is) no guarantee that other, unanticipated shocks will not occur in the future, it is clear that government stabilization programs have made the stock market inherently less risky than it was in the past.


pages: 573 words: 115,489