Wednesday, March 19, 2008

Bank Run Metaphor

Paul Krugman put together a great post explaining what happens during a bank run. He describes it as what's happens when someone yells "Fire!" in a crowded theater:

Bank runs come in two kinds.

In some cases, the bank run is a pure self-fulfilling prophecy: the bank is “fundamentally sound,” but a panic by depositors forces a too-hasty liquidation of its assets, and it goes bust. It’s as if someone calls “fire!” in a crowded theater, provoking a stampede that kills many people, even though there wasn’t actually a fire.

In other cases, the bank is fundamentally unsound — but the bank run magnifies its losses. It’s as if someone calls “Fire!” in a crowded theater, and there really is a fire — but the stampede kills people who would have survived an orderly evacuation.

We’re in the second case. The Fed has spent the last 7 months trying to assure people that there isn’t any fire. But there is.

Worse yet, thanks to decades of deregulation, the theater doesn’t have a sprinkler system - and the town the theater is in doesn’t have a fire department.

And now we have to put together an emergency response.

OK, so I thought of a third scenario. What if there really is a fire, but that manager of the theater (Bernanke, Paulson, et al.) convinces basically everyone that there is no fire. How many people die in that scenario? Better to die fighting like hell to get out of the theater than sit compliantly while the flames lick around your ankles...

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