An Early Systemic Risk Exaggeration

[T]he mischief takes a wide range. Those who have been accommodated with loans must pay, whatever their readiness or ability to do so. Further advances cannot be obtained. Other banks must call in their loans and refuse to extend credit in order to fortify themselves against the uneasiness and even terror of their own depositors. Confidence is destroyed. Enterprises are stopped. Business is brought to a standstill. Securities are enforced. Property is sacrificed, and disaster spreads from locality to locality. All these incidents of the banking business are matters of common knowledge and experience.

Court of Kansas. 1911. Schaake v. Dolley, 118 p. 80, 83 (Kansas denying a charter to a new bank because “the economy could not support another bank”).

When Runs Are Suppressed, Initiation of Insolvency Is Left to the Regulators…

Unfortunately, the decision to close an insolvent bank rests with banking regulators, who do not personally internalize the costs of delay. Regulators who prematurely close a solvent financial institution will offend the shareholders, managers, employees, and depositors of that institution. But regulators who permit an insolvent financial institution to remain open after it should be closed rarely are blamed because the costs of keeping such institutions open are widely dispersed among taxpayers, who must provide the funds necessary to bail out the deposit insurance funds.

Page 1133 of Macey, Johnathan R. and Geoffrey P. Miller. 1993. “Kaye, Scholer, FIRREA, and the Desirability of Early Closure: A View of the Kaye, Scholer Case From the Perspective of Bank Regulatory Policy.” Southern California Law Review 66,  p.1115-1143.

It’s A Dirty Job, But Someone Had To Do It

“On the whole, bank runs do not appear to deserve their bad reputation. They did a dirty job in maintaining market discipline–but someone had to do it. Eliminating dirty jobs per se does not eliminate the problems for which the jobs arose.”

Kaufman, George G. 1988. “The Truth About Bank Runs”. In The Financial Services Revolution: Policy Directions for the Future, eds. Catherine England and Thomas Huertas, pp. 9-40. Kluwer and Cato Institute.