Fear of Fire Sales and the Credit Freeze / Douglas W. Diamond, Raghuram G. Rajan.

Format:

Book

Author/Creator:

Diamond, Douglas W.

Contributor:

National Bureau of Economic Research.

Rajan, Raghuram G.

Series:

Working Paper Series (National Bureau of Economic Research) no. w14925.

NBER working paper series no. w14925

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2009.

Summary:

Is there any need to "clean" up a banking system in the midst of a crisis, by closing or recapitalizing weak banks and taking bad assets off bank balance sheets, or can one wait till the crisis is over? We argue that an "overhang" of impaired banks that may be forced to sell assets soon can reduce the current price of illiquid assets sufficiently that weak banks have no interest in selling them. Anticipating a potential future fire sale, cash rich buyers have high expected returns to holding cash, which also reduces their incentive to lock up money in term loans. The potential for a worse fire sale than necessary, as well as the associated decline in credit origination, could make the crisis worse, which is one reason it may make sense to clean up the system even in the midst of the crisis. We discuss alternative ways of cleaning up the system, and the associated costs and benefits.

Notes:

Print version record

April 2009.