The Age of the Shadow Bank Run

The New York Times
By TYLER COWEN
Published: March 24, 2012

I RECENTLY asked a group of colleagues ? and myself ? to identify the single most important development to emerge from America?s financial crisis. Most of us had a common answer: The age of the bank run has returned.

Since the end of World War II, economists have generally thought that runs on banks were dead, at least as a phenomenon in advanced nations. In the United States, for example, bank deposits are insured by the Federal Deposit Insurance Corporation, and, as a last resort, the Federal Reserve can back deposits by printing money.

The new complication is that bank deposits are no longer the dominant form of modern short-term finance. The modern bank run means a rush to withdraw from money market funds, the disappearance of reliable collateral for overnight loans between banks or the sudden pulling of short-term credit to a troubled financial institution. But these new versions are in some ways still similar to the old: both reflect the desire to pull money out of an endeavor ? and to be the first out the door. And both can set off a crash.

These newer forms occur in the so-called shadow banking system, involving short-term financial credit not guaranteed by the deposit insurance umbrella. According to the Federal Reserve Bank of New York, shadow banking accounts for about $15 trillion in assets ? more than the traditional banking system. But as recently as 1990, the shadow-banking total was much lower, at less than $4 trillion. The core problem is that the growth of short-term credit has been outracing our ability to protect it, and since 2008 most investors have realized that these shadow-banking transactions are not risk-free.

On top of this problem is the market for derivatives. The quantity of open derivatives amounts to trillions, and these positions are another source of short-term credit risk. So a need for sudden payouts could also prompt a run on a financial institution.

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Source: http://www.brotherjohnf.com/uncategorized/the-age-of-the-shadow-bank-run/

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