puffymist's Shortform

Gorton, G. (2018), Financial Crises is a survey article. I thought its explanation of banking and financial crises as information shocks was enlightening.

• via: New York Fed (2024). Tracing Bank Runs in Real Time
  • via: Twitter: Patrick McKenzie

Banking and financial crises as information shocks

Money, or bank notes, (or similar on-demand debt liabilities of a bank,) need to be information-insensitive (thus, interchangeable: $1 at Bank A == $1 at Bank B) to facilitate exchange. Otherwise, uninformed agents (any non banking-professionals) face adverse selection, haircuts on bank debts they hold, and thus withdraw from banking-facilitated commerce.

Banking crises are triggered by common-knowledge information releases (eg. news broadcast) that are unexpectedly bad (actual news worse than forecast by more than a threshold) (cites Gorton, 1988), which make "money at those particular banks" information-sensitive ($1 at those particular banks might not be worth $1).

Financial crises are slightly more general: debt liabilities of companies in general go from being information-insensitive (interchangeable: usable as general collateral, with holders indifferent between different companies' debt) to information-sensitive (particular companies' debt might not be worth face value)

Banking crises

• Frequency:

  • 147 banking crises in 1970–2011 (cites Laeven & Valencia, 2012)

• Business cycle peaks and credit booms are only loosely linked to banking crises:

  • Only about 30% of banking crises were preceded by a credit boom (cites Laeven & Valencia, 2012)
  • Most credit booms are not followed by a banking crisis (cites Gorton & Ordonez, 2018)
    • Good booms (not followed by a banking crisis): Positive and lasting shock to Total Factor Productivity (TFP) and Labour Productivity (LP)
    • Bad booms (followed by a banking crisis): Positive but transient shock to TFP and LP