Run, Run, Run: Was Financial Crisis Panic over Institution Runs Justified?

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Throughout history there has been a consistent fear of bank runs, particularly regarding large institutions during times of crisis. The financial crisis of 2007-09 was no exception. The Financial Crisis Inquiry Commission,which was created after the crisis to investigate its causes and triggering events, highlighted no less than 10 cases of runs at individual institutions. Those runs were a major consideration in the shifting policy responses that authorities employed during the crisis.

In the early stages of the crisis, troubled institutions facing runs were dealt with through a scattered blend of voluntary mergers, outright closures, and bailouts. By late September 2008 and thereafter, panic had descended on the Treasury and the major financial agencies. That resulted in the decision to backstop the full range of large institutions,as government officials feared a collapse of the entire financial system. However, serious analysis of the risks facing the financial sector was sorely lacking and outright misstatement of the facts was evident.

It did not have to be that way. Simple rules elaborated by Walter Bagehot and Anna J. Schwartz involving a systemic review of the condition of the financial system, prompt intervention, and consideration of the condition of individual institutions could have prevented the numerous ill-advised bailouts. Additionally, evidence that the runs were not indicative of a pending collapse of the system, but were rather a simple matter of migration of deposits from weaker institutions to stronger institutions, were apparently not considered or ignored. Application of these considerations could have avoided the panic by the authorities and the strategy of bailouts for the megabanks.

Vern McKinley is a Research Fellow at the Independent Institute and author of Financing Failure: A Century of Bailouts (Oakland, CA: Independent Institute, 2012).

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