Misunderstanding Financial Crises: Why We Don't See Them Coming

By Gary B. Gorton | Go to book overview

XL BANK CAPITAL

Against such panics, Banks have no security, on any system; from
their very nature they are subject to them, as at no time can there be
a Bank, or in a country, so much specie or bullion as the monied
individuals of such a country have a right to demand. Should every
man withdraw his balance from his banker on the same day, many
times the quantity of bank notes in circulation would be insufficient
to answer such a demand.

—David Ricardo

Throughout American history the banking system has been designed, by Congress or state legislatures, to try to achieve stability, to prevent crises. The Quiet Period suggests it is possible to do this successfully. There are enticements, like charter value, that encourage banks to not take too much risk. There are also regulations, like reserve requirements—how much cash a bank has to have on hand; and capital requirements, limitations on how much the bank can borrow. And there are bank examinations. Through a combination of these, stability might be achievable. But it is a delicate balance of payoffs and punishments—if there is no profit in being a bank, bank capital will exit the industry.

Conceptually, there are two issues, as George Barnett explained in 1911:

The banking question in the United States includes at least two prob-
lems. The more serious of these is the prevention of panics, such as
those which occurred in 1893 and 1907. The less urgent, but important,
problem is the minimizing of losses through bank failures. The two

-151-

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Misunderstanding Financial Crises: Why We Don't See Them Coming
Table of contents

Table of contents

  • Title Page iii
  • Contents v
  • Preface vii
  • I- Introduction 3
  • II- Creating the Quiet Period 10
  • III- Financial Crises 29
  • IV- Liquidity and Secrets 45
  • V- Credit Booms and Manias 59
  • VI- The Timing of Crises 74
  • VII- Economic Theory without History 87
  • VIII- Debt during Crises 98
  • IX- The Quiet Period and Its End 125
  • X- Moral Hazard and Too-Big­ to-Fail 134
  • XL- Bank Capital 151
  • XII- Fat Cats, Crisis Costs, and the Paradox of Financial Crises 165
  • XIII- The Panic of 2007–8 182
  • XIV- The Theory and Practice of Seeing 200
  • Bibliographic Notes 213
  • Notes 239
  • References 247
  • Index 273
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