Sunday, Dec 16, 2007
But if the rumour is true...............
New York Times: After the money's gone
Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.
Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices — and it may indeed go bust even though it didn’t really make that bum loan. And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.
Posted by lvmreader @ 12:33 AM (259 views) Add Comment
1 Comment
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1. Hotairmail said...
Excellent article. People have taken their eye off the ball. This problem is all about bad debts. They talk about $500billion of default - but that is just in the US and that is just in the sub prime area of the market.
The $500 billion has to be written off against reserves. Lending by the banks is a function of many times their reserves (for on balance sheet lending). The amount of lending out there has to be curtailed by many times the value of the bad debts....and not only that, there is the danger that many of the big banks would be insolvent if they recognised their bad debts.