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is exactly what started in the summer of 2007, and lasted until TARP was approved. At the time we were commenting that what was going on was that banks looked at their balance sheets, saw ShitPile™ and wondered if my balance sheet looks like this, what does my neighbour's balance sheet look like?. They stopped lending to each other, which qualifies as a run.

Banks lend long-term assets, and fund themselves short-term (be it deposits or borrowing in the money markets). This is in the nature of things as is unavoidable. Therefore, any bank is vulnerable to a run, which is defined as an inability to secure short-term funding to meet maturing liabilities (in other words, an inability to roll maturing short-term credit). In August 2007 the 3-month interbank market completely dried up for weeks, taking Northern Rock with it. Lehman Brothers, being a broker-dealer, had no deposits and also funded itself exclusively in the short-term money markets (repos, not Repo 105, would be an example of this). The run on the money markets took with it Bear Stearns and eventually Lehman Brothers, which I seem to recall was the smallest and by far the most highly leveraged of the four big US investment banks (Goldman Sachs, Morgan Stanley and Merrill Lynch being the other three).

In the frame of Hyman Minsky's Stabilizing an Unstable Economy banks are by definition speculative, borrowing to pay the interest on their loans (this is what rolling short-term liabilities amounts to). When their leverage exceeds a certain threshold (which is lower if interest rates rise, which is what happened in the run on interbank credit 2 years ago) they become ponzi finance (ponzi finance is not a term of abuse in Minsky, just a name for a situation where you have to borrow to pay down the principal as well as the interest).

The brainless should not be in banking -- Willem Buiter

by Carrie (migeru at eurotrib dot com) on Thu Mar 18th, 2010 at 04:47:15 AM EST
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