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Yippee! More Bank Runs in Our Future

June 7, 2013 in Economics

By Joseph Salerno

Robert Lenzner of Forbes advises that you and I will be blindsided by the next financial crisis. Lenzner bases his reasoning on Yale economist Gary Gorton’s recent book Misunderstanding Financial Crises, Why We Don’t See Them Coming . According to Gorton the old-fashioned bank run is back, only in a different form. The recent financial crisis was different from earlier ones in that it was not initiated by bank depositors scrambling to withdraw their funds. Rather it was precipitated by a “run” among short-term lenders who had purchased banks’ commercial paper or lent money to banks through “repos” (repurchase agreements). When these lenders suddenly tried to liquidate these assets by selling them or not renewing the loans, their actions deprived banks of the short-term funds that the banks had been using to finance their long-term lending and investments.

As Lenzner describes the evolution of the crisis:

What transpired in 2007-08 “resembled the bank runs of the pre-Federal Reserve era. These were primitive expressions of panic by people trying desperately to sell assets, driving the price of those assets down, and causing other people to panic as well and try to get out at the same time. The panic spread from short-term instruments like repos and commercial paper to bonds and stocks and commodities and real estate. The wave of fear sweeps from short-term investments to longer term obligations. [There is an open quotation mark in this passage before "resembling" but no closed quotation mark to indicate where the quotation from Gorton ends.]

Lenzner goes on to warn:

The playbook in the next crisis will be the same as it was in past crises from 2008 to 1987, 1929, 1907, 1893, 1857 and so on. The run on the banks becomes systemic as no one institution is spared. Credit markets freeze, the economy goes south, millions lose their jobs, and other millions have their savings decimated. It happened time and time again in the 19th century before there was a central bank, and panics didn’t stop after the Fed appeared in 1913. . . .

Expect it to happen again. Gorton warns clearly that “there is no mechanism for determining when there actually is a crisis.” In fact, there was no panic by depositors in Citibank, BankAmerica, Wells Fargo that would have alerted the nation. It required the Fed to realize how over-leveraged, …read more


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