Understanding Financial Crises

By Franklin Allen; Douglas Gale | Go to book overview

5
Financial fragility

In the preceding two chapters, we separately considered the operation of asset markets and intermediaries, such as banks. In the present chapter, we combine these elements and begin the study of their interaction. From this we will gain important insight into the phenomenon οι financial fragility. We use the phrase [financial fragility] to describe situations in which small shocks have a significant impact on the financial system. One source of financial fragility is the crucial role of liquidity in the determination of asset prices. There are many historical illustrations of this phenomenon. For example, Kindleberger (1978, pp. 107–108) argues that the immediate cause of a financial crisis

maybe trivial, a bankruptcy, a suicide, a flight, a revelation, a refusal of credit to some
borrower, some change of view which leads a significant actor to unload. Prices fall.
Expectations are reversed. The movement picks up speed. To the extent that speculators
are leveraged with borrowed money, the decline in prices leads to further calls on them
for margin or cash, and to further liquidation. As prices fall further, bank loans turn
sour, and one or more mercantile houses, banks, discount houses, or brokerages fail.
The credit system itself appears shaky and the race for liquidity is on.

A particularly interesting historical example is the financial crisis of 1763 documented by Schnabel and Shin (2004). The banks in those days were different from modern commercial banks. They did not take in deposits and make loans. Instead the [bankers] were merchants involved in the trade of goods such as wheat (this is where the term [merchant banker] comes from). Their primary financial role was to facilitate payments between parties using bills of exchange. A bill was like an IOU in which one party acknowledged that he had received a delivery of wheat, say, and promised payment at a specified future date. Sometimes reputable bankers could make their creditworthiness available to others, by allowing people known to them to draw bills on them in exchange for a fee. These bills could then be used as a means of payment or to raise capital by selling the bill in the capital market. The widespread use of these bills in financial centers, such as Amsterdam and Hamburg, led to interlocking claims among bankers.

The de Neufville brothers' banking house in Amsterdam was one of the most famous in Europe at the time. The end of the Seven Years War led to an

-126-

Notes for this page

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this book

This book has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this book

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this page

Cited page

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited page

Bookmark this page
Understanding Financial Crises
Table of contents

Table of contents

  • Title Page iii
  • Preface v
  • Contents vii
  • 1: History and Institutions 1
  • 2: Time, Uncertainty, and Liquidity 27
  • 3: Intermediation and Crises 58
  • 4: Asset Markets 99
  • 5: Financial Fragility 126
  • 6: Intermediation and Markets 153
  • 7: Optimal Regulation 190
  • 8: Money and Prices 216
  • 9: Bubbles and Crises 235
  • 10: Contagion 260
  • Index 299
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this book

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen
/ 303

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.