DP13834 Externalities and financial crisis - enough to cause collapse?

Author(s): Marcus Miller, Lei Zhang
Publication Date: July 2019
Date Revised: July 2019
Keyword(s): bank runs, cross-border banking, Illiquidity, lender of last resort, Pecuniary externalities
JEL(s): G01, G11, G24
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13834

After the boom in US subprime lending came the bust - with a run on US shadow banks. The magnitude of boom and bust were, it seems, amplified by two significant externalities triggered by aggregate shocks: the endogeneity of bank equity due to mark-to-market accounting and of bank liquidity due to 'fire-sales' of securitised assets. We show how adding a systemic 'bank run' to the canonical model of Adrian and Shin allows for a tractable analytical treatment - including the counterfactual of complete collapse that forces the Treasury and the Fed to intervene.