This book review was written by Eugene Kernes
“Panics are not irrational events. Panics happen when information arrives about a coming recession. It is the fact that there are potential problems with banks that causes a run. It is not the other way around, that runs cause problems for banks. We will see that this underlying problem of runs is distorted when consumers and firms do not run because they expect the government to act; but runs are still the underlying problem.” – Gary Gorton, Chapter 1: Introduction, Page 5
“Banks create debt so that people and firms have a way to transact. To produce debt that people and companies find useful for transactions is not easy. It would be best if this debt were riskless, like modern government-produced money, because then it would be very easy to transact. People and companies would accept the money without questions. But private firms cannot create riskless debt, and that is the basic problem. Unlike other products, bank debt comes with a kind of contractual warranty: if you don’t want it anymore, the bank has to return all your cash. But there cannot be enough cash, because the cash is lent out, leading to a multiplying process creating more than a dollar of bank debt for each dollar of cash. The cash cannot be returned fast enough.” – Gary Gorton, Chapter 1: Introduction, Page 6
“Markets are liquid when all parties to a transaction know
that there are probably not any secrets to be known: no one knows anything
about the collateral value and everyone knows that no one knows anything. In that situation it is very easy to
transact. The situation where there is
nothing to know or nothing worth knowing – no secrets – is desirable and allows
for efficient transactions.” – Gary Gorton, Chapter 4: Liquidity And Secrets,
Page 48
Is This An Overview?
Financial crises are inherent in a market system. Financial crises occurred before and after a
centralized currency, before and after the development of a central bank. Each crisis has different characteristics,
but a common structural cause. Financial
crises occur when people and firms do not want the product of a bank. The product of a bank, is debt. Debt is used for transactions. Different eras have different forms of bank
debt, such as banknotes and repurchase agreements. The debt is not riskless, and banks do not
hold the cash needed to repay all the debt, as they lend out cash.
Debt is used for transactions, which depends on the lack of
secrecy. That each party knows the value
of the collateral being exchanged, and neither knows more than the other. But when people become uncertain of the value
of bank debt, people trigger a bank run.
No matter the form of the debt, crisis are caused by an avoidance of
what the bank have to offer. Crisis are
triggered by the panic that ensues.
A panic caused by problems with the banks, rather than
panics causing the bank problems. A
financial crisis is when many consumers and firms are demanding more cash from
the banking system than what the banks can provide, a contractual demand that
the banking system cannot satisfy.
Events that cause a crisis are unpredictable, but the financial systems’
fragility can be observed. Financial
system fragility depends on the amount of credit outstanding. Before a financial crisis, there is a credit
boom that increases the financial systems’ fragility.
Caveats?
This book provides an introduction to the cause of financial
crises. More research would be needed
understand any specific crisis.
The book can be difficult to read. There are a variety of excerpts provided to
be historic evidence to claims, but they have mixed results. The excerpts can help explain the situation
or be distracting.
