Dollars and Jens
Saturday, December 20, 2008
how finance is weird
In the mid-1980s, a long line in front of a Hong Kong pastry shop adjacent to a bank triggered a bank run. Depositors assumed that the line was headed into the bank; word spread rapidly; soon, the bank was mobbed.
From The Panic of 1907, by Bruner and Carr.

As I've indicated before, any financial institution has an illiquid, even insolvent (in at least some sense) equilibrium as a function of perceived risk, but for financial institutions with solvent equilibria, that is the socially optimum one. The trick with attempts to favor the solvent equilibrium is that, if there isn't one, those attempts can result in the destruction of economic resources that ought to be redeployed, in the same way that propping up any other inherently insolvent company does.

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